Investors in Honeywell (HON) are slightly disappointed with a soft outlook for the current first quarter. While Honeywell moves along nicely on its margin expansion trajectory, the current valuation has increased significantly on historical standards. At this point in the cycle, despite the solid strategy, I remain cautious and stay on the sidelines.
Solid End To 2013
Honeywell reported fourth quarter revenues of $10.39 billion, up 8.4% on the year before, and ahead of consensus estimates at $10.2 billion.
The company reported fourth quarter earnings of $964 million, up significantly from the $255 million reported last year. Diluted earnings per share came in at $1.19 per share. Adjusted earnings of $1.24 per share came in ahead of consensus estimates at $1.21 per share.
The results marked the end of 2013 a very successful year for Honeywell in which revenues rose to $39.06 billion while earnings advanced to $3.96 billion.
Reported revenue growth of 8.4% in the final quarter was solid, driven by 5% organic growth. Fourth quarter growth easily surpassed the annual growth rates of 3.7%.
Despite the strong growth in revenues, absolute cost of goods sold actually fell slightly, being a huge boost to margins and earnings.
The aerospace business reported third quarter revenues of $3.10 billion, up 3% on the year before after reporting flat growth for the year. Commercial growth and excellence boosted segment margins by 60 basis points to 20.5% of sales.
The automation and control business reported solid 10% revenue growth for the final quarter, to $4.58 billion. Acquisitions and innovations drove results even as margins fell by 20 basis points to 15.3% due to dilutive acquisitions.
Performance materials and technologies segment's sales growth accelerated to 12% in the final quarter, driven by the Thomas Russell acquisition and solid organic growth. Strong sales leverage and productivity resulted in 210 basis points expansion to 15.7% of sales.
Transportation was the best performing business, reporting 16% revenue growth as margins rose by 250 basis points to 13.6%. New launches and an uptick in Chinese vehicle demand drove results.
Outlook For 2014
For the current year, Honeywell sees revenues of $40.3 to $40.7 billion, up 3-4% compared to 2013. Segment margins are expected to improve by 30 to 60 basis points to 16.6-16.9%.
Operating margins are expected to show greater improvements, increasing 100 to 130 basis points to 15.2-15.5%. This should result in earnings per share of $5.35-$5.55 per share, up 8 to 12% compared to 2013.
While Honeywell is guiding for solid full year growth, the guidance for the first quarter is a bit soft. Revenues are seen between $9.6 and $9.8 billion, below consensus estimates at $9.87 billion. Excluding the impact of sales and acquisitions, organic revenue growth will slow down to 2-4%, down from a 5% reported in the fourth quarter. The company remains confident that the growth picture remains intact.
Efficiency Is Driving Earnings And Returns
Over the past year, net earnings of Honeywell expanded to 10% after tax. Revenues rose by 20% over the past three years while earnings doubled and Honeywell has been able to continuously find efficiency gains. Further improvements are seen in the coming year.
These achievements have driven returns for investors as shares have risen from lows of just $25 in 2009 to current highs approaching $90. Increased dividends to $0.45 per quarter, provides investors with a 2.0% dividend yield in the meantime. While Honeywell has complemented this with accretive acquisitions, Honeywell still has a solid balance sheet. The firm holds $6.4 billion in cash and liquidity, operating with a modest net debt position of just $0.5 billion.
What's Left For Shareholders?
After the strong run-up in recent years as part of its five-year plan, Honeywell is now a $70 billion industrial conglomerate. After shares saw 30% returns over the past year, which are in line with the wider market, they trade at 17-18 times earnings.
As such shares have been driven on the back of relatively modest sales growth, aggressive margin expansion and valuation multiple expansion, which is driven by lower interest rates. As margin expansion possibilities going forward might be exhausted at some point in time, and rates could increase, the risk-reward ratio is not too compelling for shareholders at this point. How much could lower rates and multiple expansion really drive shares forward at this point?
Key points to look forward to remain margins, especially after 2014 as Honeywell remains vulnerable, just like the rest of the market, to tapering by the Federal Reserve.
Therefore, I can only conclude that shares are "fairly" valued, yet I don't see reasons for excessive optimism or pessimism at current levels. I remain on the sidelines.