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Honeywell International, Inc. (NYSE:HON)

BofA Merrill Lynch Global Industries Conference

December 06, 2011 3:15 pm ET

Executives

Andreas Kramvis - Chief Executive Officer of Specialty Materials and President of Specialty Materials

Analysts

Unknown Analyst

John G. Inch - BofA Merrill Lynch, Research Division

John G. Inch - BofA Merrill Lynch, Research Division

It gives me great pleasure to introduce the management team of Honeywell. Andreas Kramvis is President and CEO of Specialty Materials. He has been with Honeywell for 11 years. He is a well-respected business leader, having spearheaded initiatives at ECC and other divisions within the company to drive productivity and performance improvement. I think this segment specifically is testament to the opportunity both at Honeywell and to Andreas's leadership.

And I do want to mention, there is a cocktail at -- right after this meeting. The drinks are free, I mean, you paid for them. But the drinks are free and on Bank of America, so that's even more incentive to stick around and get the scoop.

Okay, with that, let me pass the mic over to Andreas.

Andreas Kramvis

Thanks, John. Good afternoon. I'm just going to give you an update with what's happening on Specialty Materials, and then we'll have some time for Q&A. I guess, you've seen the statements plenty of times, so I won't leave it there for a long time.

Specialty Materials will do this year close to $5.7 million. Our business is really global. We are more than 60% outside the United States. We break the business down between 2 segments, Advanced Materials and UOP. And I'll dig into both those segments today and give you an idea of what's going on.

Our business has performed extremely well over the last few years, 2011 has been a terrific year. I guess, I didn't mention in the first slide that we're up 270 basis points in our margins. So that's a very strong position to be in.

What are we seeing going forward by segment is that our UOP business continues to be a strong business, following a strong 2011. We are seeing strength in our Resins and Chemicals business, a very global business. Our Fluorine Products business, which has been stellar in the year, we think that supply and demand will come in balance. But we have a lot of new products. And the other 2 businesses there, I think, the story is about the same. While the market is not as heated as it used to be, we have a very full pipeline of new products, and I'll be talking about those.

What are the key differentiators, and why are we performing so well? Well, I guess, everybody ascribes to something, but this is what we've been ascribing for the last few years. A very strong operating method for the business. It's fairly unique business decision week. We are extremely well equipped in labs, extremely well oriented to technology, something that's very difficult to copy and, of course, that's coming through in terrific new inventions and molecules. And we have been getting substantial productivity out of our plants.

Now traditionally, we've been comparing what we do with the green curve and the right curve being Honeywell. The green one being specialty materials of other companies. We've kind of introduced this time, the blue curve, which is the crown jewels of other multi-industry companies. I'm not quite sure you can make the small print at the bottom, but have included UTX Otis, Tyco from ADT, from Emerson Process Management, from Danaher Test & Measurement, et cetera. So we think -- well, I think the performance of this division is getting into the -- closing the gap with the best of the best.

Now it's -- when you hear about a division of a business or a group, you kind of think of one business. We're not really one business. And I think the plurality with which we are capable of managing these different businesses has led to the success we have. Some of our businesses, like fluorine products, Resins and Chemicals, are what we call new molecule and scale-up. These are large, long cycle businesses, fairly large investments where you bring out new molecules to the market and establish end applications around the globe.

Our technology leadership business is in UOP, where we again, we have terrific new product development, and then we work with others to commercialize and license. And then we have what we call our fast-cycle application business, which is on the basis of technology platforms, which we modify in a shorter timeframe, we're able to penetrate markets around the world.

Having this balance gives us a very good portfolio, which can really both look at the long-term, invest long term, but also get results short term and kind of meet the requirements for our shareholders.

So I'll go through each one of these businesses, give you a flavor with what's happening. Our Fluorine Products business major leads and we're a leader here. We call it heat transfer; really we're a refrigerants business. Our scientists have really invented what you're using in your homes and your cars today; major supplier, and also in insulation, with how your refrigerators are insulated, and homes.

As you can see, while the housing market hasn't been great and some of these markets haven't performed in markets, we have one, that blue line is winning around the globe. A lot of it is our ability to serve people and our labs to fit in new applications. But it's also that people know that this industry will have to move into from none other than depletion to low global warming.

And this is where we have -- we're coming through now with a suite of new molecules to address all these issues. This is where the portfolio is. This is Specialty Materials. Honeywell is the company that has been able to make these inventions and commercialize them, begin to commercialize them around the globe.

So over the next few years, it's already started in Europe, starting with shipping all the things that we have here from pilot plants. The air conditioning fluid you're using is going to change to a low global warming one. The reason that they want ours is that it's backwards compatible, performance is great, safety is great. Obviously, the environment is being served.

Similarly for aerosols, foaming insulation, a new generation, which brings those same -- that same performance. And we have new blends for stationary air conditioning, which perform better.

Now our Resins and Chemicals business is based on a very good cost position we have in Caprolactam, which is the basis of nylon 6 in our resins business. We've added phenol intermediates to protect the supply this year. It's been a move we are very happy about, although it's diluting our margins. But even with that, we will come at the 18.5% for the year.

The beauty of this business is that this global demand, we're a major exporter. Population is going up. People need carpets and clothing. And they do need more and more of tire cord. And it's a tough technology, and we think that the equilibrium is going to be good for a number of years.

You may have caught a new investment we announced, certainly made The New York Times Saturday and Sunday, in a new fertilizer that really does not explode. It cannot be used as a bomb. We are having a pilot plan go or a major plan go up with simplet [ph] in California. So that's going to be down the -- a new, very useful line of business.

Our Specialty Products business, we have here applications on the basis of very solid technology in a lot of niches around the world. And I really like this business because it's not -- it's something that we can gain new markets on a daily basis. In some of these areas, like our specialty additives, we actually have to triage the kind of things we can do. And we have at any time a funnel of 500 new opportunities we are looking. So we just undertake the ones we think we can do.

Clearly, they are not huge. But this is the kind of continuous single winning of our business, and some of them are big. And now just to give you an idea here, our performance films, this is high-barrier protects against moisture. When you see pharmaceuticals that are see-through, that cannot take moisture instead of having an aluminum foil. It's our technology. It's called Aclar technology. It's growing every year. We keep producing more and more effective barriers, depending what the pharmaceuticals require.

We have introduced some extremely good barriers for photovoltaics. And as many of you may know, the main reason for degradation for photovoltaics over time is that moisture gets into them. So this is a major item.

If I take a high-strength fibers, Spectra is what we are protecting soldiers in whatever they are doing in the Middle East and in Afghanistan. And we have new inventions where basically the fiber is weightless and stops a faster bullet. If you -- those of you who have been in the Marines and the Army, you know this means a lot, especially if you're carrying around a helmet of 8 pounds, which today doesn't do that much and we got new applications that can do a lot better.

Specialty additives, terrific new application in asphalt, putting it down in a lot -- with a lot less energy, rolling it around the world, new additives for oral care. The new Crest that's coming out in Europe with GSK has very special additives from us. And we are a good niche player in electronic materials. Every single chip, for instance, of Intel since 1990 uses our electronic polymers to be made. In the new 300-millimeter sputtering targets, we are a leader. So we have some good technologies.

Now let me switch to UOP, which I think is a great market name. And around the globe, it's certainly a pleasure to go and see customers because we are really in every single refinery around the world, and some of these places are really in the back and beyond.

And I just want to give you an idea of what we do here. UOP is split into petrochemicals, refining, gas hydrogen and adsorbents. And it's a business that has, I think has a lot of demand. Emerging region growth is something that is happening. People are buying a lot of new cars, they need transportation fuel, so there's continued capacity expansion.

We're seeing around the world improved refining margins, even here in the U.S. given some of the liquids that are coming out of gas. So that's helping the refiners. Shale gas development is key, and gas is becoming a big item. And we are people who can clean gas and put it in the pipe. You're going to ask questions like what does soluble ability do for you? Frankly, for us it doesn't. The kind of projects we work with are very long term. Financial uncertainty has an impact because some of the projects we work with are very major. At the moment, we are not seeing people pulling back with all the volatility we're seeing in the market. And Mideast's unrest, I think it's affecting us extremely a lot more than down downstream.

So just to explain what do we do, it's one of our -- the business we have where people have the most difficulty in understanding what we do. Fundamentally, we'll take crude oil and put the technology in place, like an architect do, and then the fundamental technology to transform it to something that we can all use, like a gasoline or diesel or a petrochemical feedstock.

At the same time, we'll take the petrochemicals feedstock and take it into produce another chemical called para-xylene. You know it is the tree that makes polyester; a very big line. Propylene, you heard of polypropylene. Phenol is used in industrial items like polycarbonates. And LAB is frankly the basis for detergents that we all use every day. So we have very unique technologies in these areas in terms of the process, which means how you design it, and then the catalysts, the chemicals that make this work.

We are a leader in cleaning natural gas. It never comes cleaner, or mostly doesn't come clean out of the ground. You need to take things out of it to put it in a usable form. And of course, we are the leader in backward-compatible or not ethanol -- we're talking about the real molecules in renewables.

So very quickly, again, you're a refiner, you want to build a refinery these days. If you don't have 2 digits and a B in front of it, you're not in the game. And you're looking to buy crude from anywhere, you want that flexibility, and crudes are changing all the time and you want to get out of it. What is transportation fuels? You want to have the bottom of the barrel be minimized. That's how you're going to basically optimize this complex, which is going to be over hundreds and hundreds of acres to get you the right -- the money out of it.

And we believe that a refining business is -- has a good growth in it. And I know oil demand is growing, according to GDP, 1 million, 1.5 million barrels a day, going up from 87, 88. That's their numbers. We're now at record numbers. However, when it comes to refining, you got to stay competitive. You got to meet environmental regulations. You've got to be -- if you're in China, it doesn't -- it's no good if someone else has that capacity somewhere else. You want national security issue. So we think this is a 5% to 8% growth type market.

And what are we seeing around the world is that people require the kind of technology we have. This is -- these are actual examples of us designing refineries and why our win rate is so high. And this is, again, a name you can -- you're talking, as I said in the $10 billion area type project. And here, we've been able to -- we have a technology to boost the yield so that for every metric ton, you get of more diesel, you get $270 more. And we meet an incremental conversion to hire fuel value so far at 60%.

So again, the NPV of the project, and all the bankers love that, it's $2.3 billion better. That's why we get involved. And we have the credibility as a business that people -- when we say we can do something, obviously, we give guarantees, we can do it, and we then execute.

You're hearing a lot about crude getting heavier. What does it mean? It's more gungy, it's more difficult to trade. And of course, when you finish at the end of the refinery, you want all the light stuff you put in your car. And we have now introduced new technologies that can increase the conversion by a 4% to 6%. So if you got a 300,000 barrel a day refinery, someone is making you a gift of 12,000 barrels a day free because the process is better. The chemistry is better, the process is better.

So in a typical investment like this one for the bottom side be under $2 billion. You're going to see a $300 million type of NPV additional to what other people can do. And again, we're taking a new position or a position in larger refineries that because we have such a large technology -- spectrum of technology of designing -- of delivering the architecture and optimizing soup to nuts, which gets a $10 billion project 1 year earlier, that means a lot of money. And indeed, creates the kind of customer value you're seeing here on this large projects because you are optimizing at the same time without things falling between the cracks.

So, so much for refining. Our petrochemicals industry, things are looking good again. I'll talk about -- you probably hear a lot about ethylene, we are not in that area. That technology is not -- is just open-heart. But when you want to get para-xylene, the thing that gets you polyester, you generally will have to come to UOP, to Honeywell.

And it's an area that we are seeing demand growth, and we expect something like 15, 12 million metric tons of capacity to come in another 4 -- the next 4 or 5, 6 years. So it's a large number of plants here.

On the bottom again, I have another chain, which is propylene. You probably heard of polypropylene. We get a lot of products out of that chain. And what is happening is that the emergence of natural gas in Middle East, here, everywhere else, is causing the supply chain to change. And you can get propylene now out of natural gas, if you have the technology we have, and we're the leading providers of that technology. So you can get propylene at a much lower cost than getting it out of the refinery.

So again, I have here typical -- a large trains of para-xylene, polyester in your words, that we can bring a customer value of over $400 million on a typical investment, which would be this sort of investment, a couple of billion dollars. These are very big items by converting more and using a lot less energy. And of course, it's the reason why we're winning.

We are converting the propane gas into propylene. This is kind of the economics are shifted radically in this area in the last year. I guess, maybe it's 2 years, people took a while to think. There has been 7 such projects awarded in the last 12 months or since this chain started. We won 6 of them because of the kind of economics we have here. And we've now introduced and closed in China a new route to getting both propylene and ethylene and sold an anchor project from coal.

So overall, UOP, we feel good about it. I mentioned the propylene wins, the methanol and the coal to olefins wins, a large number of FPSOs, floating, production and storage basically, on a ship because it's clear -- clean gas processing technology.

Something we're very proud of. Our adsorbents business went -- the problem happened in Fukushima. You heard about them -- about using a lot of seawater, became radioactive a lot of it, how do you claim it. We went into the Toshiba reactor there, and there was another method, adopted something we provided and developed very fast for them, and the results are terrific. We've cleaned the water. So this is a new business for us. And green jet fuel. We have certifications made the first transatlantic flights.

So let me go back to the overall business, Specialty Materials, overall, people talk about emerging regions, well, we're there, 45% of our revenue comes from these regions. And we're seeing, because of what we have here, growth, continued growth.

Operational excellence, I mentioned to you Honeywell operating system. You've been -- for those of you who follow Honeywell, you've been hearing of that. And this is some results of the 3-year's time of major plants how volume has gone up with essentially the same assets and costs, unit costs have come out disproportionately. And of course, this is one of the reasons our margins are where they are.

Technology, we're very proud of it. I have in my group, this is a high know-how group, knowledge group. I have just 9,000 people under that; 1,000 there in the lab; an additional 2,500 are engineers. And we have a terrific pipeline of new products that are coming out over a few billion dollars, as you can see here, over the next 3, 4 years.

So in summary, we feel good about the business. The new product pipelines are very strong. I think our deployment is strong around the globe, and we expect to continue to perform along the guidance we've given you in -- over the long term. Thanks for that. And I guess, I'll back to open it up for questions.

Question-and-Answer Session

John G. Inch - BofA Merrill Lynch, Research Division

Yes. Let me kick things off a bit here. Talking about the capacity, globally, clearly, how utilization of your factories is driving or has driven your margins where they are. That said, I think that probably -- and you and Andreas have talked about the need to invest in capacity. Where is that capacity going? And it just gives us a little sense of sort of how you see the associative margin impact play out?

Andreas Kramvis

Right. Well, that's a great question. We are generally working at very high utilization. In terms of the way we are looking at it in a huge kind of chemical plant, the first thing you got to look at is what does capacity mean? Is it all constraint or is, do you have constraints in 1 or 2 areas? So in products that have been around for a while, we're working very hard to debottleneck, as we call it, and spend a few million dollars to increase capacity. This has very high return investments.

At the same time, we have a lot of new products that require new productive capacity, and that some of them are really protected nicely by patents. So we will be -- we are putting money behind those investments. For instance, we announced an investment in Louisiana 60 days ago to produce the new low global warming molecule for aerosols. That's a clearly, it's heavily patented, great market. We have orders. So that's the kind of method we're going to go. We announced a joint venture with Cyno-Chem, again, in the last maybe 4 weeks ago to build with them in China a new generation of blowing agents with a vehicle going further down the road. So those are the 2 areas, John, new molecules, big future. We are putting serious money down. They hold it once, we're debottlenecking and balancing demand and supply.

John G. Inch - BofA Merrill Lynch, Research Division

So from a numbers perspective, how much capacity do you need to add? Because, clearly, you're -- the longest cycle seemed to be just starting to pick up, whether at the UOP or demand...

Andreas Kramvis

Yes. If I take UOP, I think this is, over the next 4 or 5 years, there's significant capacity to go in. Because as we build new plants, you got 3 years to build them, then, today, the first day they operate, they're going to need catalysts. And so it's something in terms of 20%, 30% type of increases in a lot of areas and some other areas more. So we are looking at our old products going away, our new products coming, so it's big, big numbers.

John G. Inch - BofA Merrill Lynch, Research Division

20%, 30%?

Andreas Kramvis

Yes.

John G. Inch - BofA Merrill Lynch, Research Division

What do you think are the major competitive risks to your business?

Andreas Kramvis

You got to run faster than the other guy; I think we're doing that. And as we are increasing the distance between us and competitors in many cases, obviously, it gives us more margin. I don't want to name particular competitors. I think in most areas we are in, we are not really holding back on any opportunity that we know of. And starting from the very strong R&D base we have -- and it's not, it's just people and capital. Very experienced people and capital. We just -- when we see something that makes sense, could be 3 years down the road, but we'll put a program on it. So I feel very strongly about our competitive position. I think we're doing the right things. We're not trying to win the quarter by not doing the right things. The quarters are happening because we've taken that attitude for a long time.

John G. Inch - BofA Merrill Lynch, Research Division

So your refinery utilization benefit at UOP, why would a refinery not use UOP products? I mean, and what's the dollar value?

Andreas Kramvis

I bring in some of the sales force.

John G. Inch - BofA Merrill Lynch, Research Division

Not, but what's the dollar -- so an average refinery is going to use, basically, what amount of Honeywell content? What's the dollar value in a year?

Andreas Kramvis

Well, it's hard. It depends on the process, John. It's hard to give you a number like that. But clearly, the more refineries you build with your technology, the base goes up every year.

John G. Inch - BofA Merrill Lynch, Research Division

And China? I'm sorry...

Unknown Analyst

Regarding your chemicals for the refining business, is that being driven -- is the demand for that being driven by the maybe older refineries in the U.S. and Europe that might have lower product yields rather than the newer refineries, or what are the...

Andreas Kramvis

All of the above. It's driven by new refineries and old refineries. As you go through different processes, it's not just one process to go from the thick stuff to the stuff you put in your car. And you require catalysts at every stage. And some of them have a -- some of them are continuous consumption, some of them are 2 years, some of them are 10 years, some refineries can kind of go beyond the life of the thing and they say, "Oh, I can stretch it out." So it depends on what you're doing. It's a mixed bag. Certainly, that can cause some cyclicality for our business, so cyclicalities that don't work. You get one quarter, a huge guidance a period of sales, some movement from quarter-to-quarter. But generally, a lot of things are out there to give us a discount balance.

John G. Inch - BofA Merrill Lynch, Research Division

Is there a scientific logic behind your portfolio? You're making the building blocks, the carpet fibers, blowing things in your refrigerator, like whatever, chemicals and -- but what's -- why do you have all these things? Like what is this about and then what sort of the logic here?

Andreas Kramvis

John, I've been running this business, I guess, since beginning of 2008. And ours is not to ask why, but to make money. And money we're making, I think that it's a good portfolio. I think that where the portfolio has been weak, we have invested to improve it. And there was a lot of divestment before I came on the scene to get rid of things that we didn't think we could improve. Now the level is performing now. If you ask people in 5 years, they probably said we never thought he would do that. But if you ask me, do I think we can continue to perform at a high level? I think the answer is yes. Now it's a bit of it happens inside the leader, unlike chemical, did whatever it did and divested whatever it did, but it's a hard portfolio to reproduce. It has a lot of good technology in it.

John G. Inch - BofA Merrill Lynch, Research Division

Pricing?

Andreas Kramvis

Pricing in the marketplace, well, I think you heard the previous -- I answered to the previous speaker. In our case, I think in 1 or 2 areas, pricing may have peaked. At the same time, you win pricing by getting new products. And if you ask me where my eye is for the future, it is on these new products that I know will enable better pricing. We will not bring a product out that doesn't have enough value for the customer, enough utility for the customer, not to allow Honeywell to keep a piece.

John G. Inch - BofA Merrill Lynch, Research Division

To help people, why has pricing peaked in what areas? What's that about?

Andreas Kramvis

Well, I think we signaled in our Fluorines business that demand and supply were out of line. I think our expectation is that it will be more in line going into next year. We haven't seen it yet, but that's our expectation, that's the planning basis we have. And I think that's what we've told -- we've said in our previous investor calls. It's chemistry, it's microeconomics over time, abundant supply.

John G. Inch - BofA Merrill Lynch, Research Division

China? How big is it? What do you do there? And...

Andreas Kramvis

China is very big for us. A whole of the -- I do 25% of my sales in the -- takes China, North Korea, Southeast Asia, it's been a great market. And for us, it's a big export market because a lot of our assets are in the U.S. I think the media are reporting and the economists reporting that there has been some weakness in the market, I think it's correct. Having said that, if you've got the right products, people still want them. But I think the tightening of -- that happened last year has taken out of the economy credit. And the move that was made last week by the Bank of China, I think, was timely.

John G. Inch - BofA Merrill Lynch, Research Division

So 25% of your revenues are in that part of the world. What kind of growth rates had you experienced? And what are you experiencing today?

Andreas Kramvis

Well, I think we'll continue to grow. I mean, we're growing 10%, 15% a year, 20% a year, I mean, these are big numbers. I mean, if I give you an example of our Resins and Chemicals business, we were 100% U.S.-based to $1.4 billion business. And in 4 years, China has taken 20% and moved to other places around the world. So we've had big success in China.

John G. Inch - BofA Merrill Lynch, Research Division

Now the facilities in that part of the world as aggressive adopters of your technology in Europe and North America. Presumably not, but...

Andreas Kramvis

In terms of them copying the kind of plants or the usage of the product?

John G. Inch - BofA Merrill Lynch, Research Division

Really, the usage.

Andreas Kramvis

Yes, yes. I think there are some segments in China in really high-tech segments that some companies, and I'm not going to name anybody, assume they're all of being national champions and don't always look at the share economics. But for each one of them, there's someone else who says, "Yes, I'm going to buy the best," and they do. So generally, I think that restrictive thinking is in a few areas and in most areas, the better product does win.

John G. Inch - BofA Merrill Lynch, Research Division

And then UOP, working with the Process Solutions, yet you're the head of Specialty Materials. How do you, as head of Specialty Materials, interface with Roger or whatever to sort of -- I mean, how does the control responsibility work? How do you -- how are you driving UOP to work with process to, in turn, drive revenue synergy?

Andreas Kramvis

Well, we clearly work very closely. I think we're at a different part in the sale cycle. If you're thinking to go and find $10 billion to make a refinery, the first thing you do is say, hi, you go to the architect like you -- you're going to build your home. So you're going to call UOP, and they're going to work for a couple of years to do feasibility studies, understand where you're going to buy the crude, how you bat. And after that gets solidified and you get your money, you're going to get to a design stage. And it's at that stage that an HPS is going to come in. And that's where connection matters.

John G. Inch - BofA Merrill Lynch, Research Division

Okay, okay. Thanks so much. Thank you very much.

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