Circling Back, Honeywell Still Looks Too Cheap

| About: Honeywell International, (HON)

Summary

Honeywell didn't do as well as some peers relative to fourth-quarter expectations, but its revenue and margin performance was superior to that of most comparables in most respects.

2016 is looking like a rough year for multiple businesses, but the company remains structurally leveraged to growth in commercial aviation, building automation, and specialty materials.

If Honeywell can manage better than 6% long-term FCF growth, a fair value of $108 is in play today.

After a pretty typically Honeywell (NYSE:HON) quarter, I'm a little surprised that the shares are as reasonably priced as they are. Although the market is pretty lousy right now, Honeywell is the kind of stock that I'm accustomed to seeing trade above, if not well above, fair value, due in large part to its (rightly) perceived quality. And yet, the shares still look around 5-15% undervalued.

Although Honeywell is not likely to be a dramatic outperformer, I think this is a pretty good price to acquire shares of a company that is more than just "pretty good" and could be a cornerstone holding for patient investors.

Not Much Drama In These Numbers

I guess I could complain that Honeywell didn't beat expectations in a quarter where ABB Ltd. (NYSE:ABB), Emerson Electric (NYSE:EMR), Rockwell Automation (NYSE:ROK), and Siemens (OTCPK:SIEGY) did, but I think that would be pretty unfair considering that a lot of those beats were of the "less bad" variety, and Honeywell had some notable positives.

Revenue was flat to down 1% on a core basis, with Aerospace up 2%, Automation and Control Solutions (or ACS) flat, and Performance Materials and Technologies (or PMT) down 4%. Gross margin was up strongly on both an as-reported and adjusted basis (up three points on the less flattering basis), and segment profits were up about 14%, with segment margin up almost three points. Operating was up 16% as-reported and 21% adjusted, with pretty much all of that gross margin leverage preserved.

Aero Cleared For Takeoff, But There Will Be Delays

Nothing has changed to make me think that 2016 won't be a good year for commercial aerospace, and Honeywell reported 9% growth in its Commercial OE business and 3% growth in its Commercial Aftermarket business to close out 2015. Management's guidance for a mid-single digit decline in 2016 stems from incentives it gave OEMs like Boeing (NYSE:BA) to win business, but the underlying business would otherwise grow at a low-single digit rate.

Defense was down 1% this quarter, but management is looking for a low-single digit improvement in the coming year. There is comparability between Honeywell and Microsemi (NASDAQ:MSCC) (a semiconductor company), which is looking for better defense sales in 2016 and a long-awaited improvement in the satellite business.

Transportation was up 1% this quarter, as Honeywell reported good results in the passenger vehicle space that offset weakness in commercial vehicles. Commercial vehicles are probably going to weigh more heavily in 2016 given the weakening truck market (and management guided for low- to mid-single digit growth), but Honeywell at least has the advantage of being relatively less exposed to Volkswagen (OTCPK:VLKAY) than Mitsubishi Heavy Industries (OTCPK:MHVYF) and IHI (OTC:IHICF). While BorgWarner (NYSE:BWA) reported stronger sales growth in the fourth quarter (up 7%), its guidance for the year (org revenue growth of 2.5-5.5%) fits Honeywell's view.

Looking past the incentive-related pressure in 2016, Aero (specifically, commercial aerospace) looks like a good market for Honeywell for several years. There's plenty of competition in the market, with United Technologies (NYSE:UTX), General Electric (NYSE:GE), Rockwell Collins (NYSE:COL), and Parker-Hannifin (NYSE:PH), but Honeywell has solid wins, and those incentives should help ensure the company is well placed to leverage increased build rates in the coming years.

ACS Okay

There's not a lot to get excited about right now in the ACS business, but it's not exactly a weak business either. Revenue was flat on a core basis, with Energy, Safety, and Security down 1% on weaker sensing product sales, while Building Solutions and Distribution was up 3%. Margin leverage was more modest here as well, as segment profits increased less than 1% and margin improved by 70bp.

Honeywell is only looking for low-single digit growth in both ESS and BSD in 2016, and I'm starting to think my expectations of a stronger non-residential market in 2016 are/were too optimistic. Siemens reported 3% growth in revenue and orders for its Building Tech segment, and likewise, there wasn't anything too exciting out of United Technologies. I'd also note that Emerson's Climate business - which is very different than Honeywell, but includes commercial HVAC compressors and controls - has been pretty weak of late.

PMT An Odd Mix

Honeywell's PMT business saw a weaker-than-expected 4% decline in core PMT sales, but profits did improve about 9%, with a nearly four-point improvement in margin. Although ABB, Emerson, and Siemens all reported weakness in their process automation businesses, Honeywell's Process Solutions business saw flat core revenue performance, as lower field instrumentation sales were offset by software. UOP was down on lower gas processing orders, while Advanced Materials declined 12% as a sharp drop in Resins & Chemicals offset better flourine sales (particularly Solstice).

It looks like mixed results will continue to be the story for some time here. UOP is forecast down mid-single digits on weaker catalysts, while Advanced Materials is expected to rise by mid-single digits, helped by Solstice. Somehow, Honeywell continues to look for flat performance in Process Solutions despite the ongoing crapalanche in the oil & gas sector (a major process automation end market, but not so much so for Honeywell, given more exposure to markets like pulp/paper and pharma).

Keep On Keeping On

Judging by management's comments on the earnings call, there's no reason to expect any major changes in Honeywell's operating plans. It has minimal exposure/risk to the Johnson Controls (NYSE:JCI)-Tyco (NYSE:TYC) deal, Solstice is growing well, and the company is looking to increase its focus on software development (something that ABB wants to do as well, but is starting much further back). Honeywell is also keep its options open with respect to M&A, with the recent $480 million deal for Xtralis (a maker of smoke detectors, security, and video products for buildings) probably a good example of what management is looking for in future deals (albeit probably not at such high multiples, if possible).

I'm not really changing much about my model, and I'm looking for revenue growth in the neighborhood of 4% and FCF growth around 7%. Discounted back, that gives me a fair value of almost $108 (versus $106 back in mid-January).

The Bottom Line

I keep asking myself what I'm missing with Honeywell, as companies with good margins, good ROICs, and a solid reputation on the Street generally trade for more than their cash flow says they're worth. I understand that the market has soured on industrial conglomerates, but this too shall pass, and I think patient investors still have a solid opportunity here today.

Disclosure: I am/we are long ABB, MSCC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.