For investors looking for meaningful diversification, conglomerates are an obvious pick. Some, however, are diversified in more undervalued business than others. In this article, I will run you through a DCF model on Honeywell (HON) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to peers. I consider General Electric (GE), 3M (MMM), and Danaher (DHR) to be reasonably similar peers. Of the stocks highlighted herein, I find that GE has the strongest investment thesis going for it.
First, let's begin with an assumption about the top-line. Honeywell finished FY2011 with $36.5B in revenue, which represented a 12.9% gain off of the preceding year: acceleration. Analysts model per annum growth of 14% over the next half decade or so. I view this as being on the bullish-side given that it is about 300 basis points higher than what is expected for the S&P 500.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to hover around 77.4% of revenue versus 14.4% for SG&A, and 2.1% for capex. Taxes are estimated at 27% of adjusted EBIT (i.e. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I model this hovering around 0.1% over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 9% yields a fair value figure of $55.48, implying that the market has it just about right for now.
All of this falls within the context of strong operating performance:
Our track record is terrific. And at every stage of the game, we've done what we said we would and we'll show you the data of course because it is good. Strategies stay consistent. We take a look at the last 10 years, we're not the guys who have a strategy, change it 2 years later, pursue it, change it 2 years later. We actually been pretty consistent in the strategy we've pursued because it's worked. Then the evolution is going to continue and we'll break out the stuff that stays the same and the stuff that changes over time. But the whole point of evolution is important because you have to keep adapting.
From a multiples perspective, Honeywell is decently priced. It trades at 24.9x past earnings, but only 11.7x forward earnings. Corresponding figures for competitors are as follows: GE (15.4x and 10.7x); 3M (14.4x and 12.4x); and Danaher (19.5x and 14.6x).
Consensus estimates for GE's EPS forecast that it will grow by 12.4% to $1.54 in 2012 and then by 14.3% and 18.8% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $24.22, implying 28.3% upside. Despite the origin in consumer electronics, GE has really become exposed to the financial sector. It thus carries much more risk than what many retail investors may acknowledge. More experienced investors who appropriately risk discount the future streams of free cash flow will find the company thus less undervalued than GE appears at first glance. With that said, the company has a strong brand and has favorable support on the Street. Moreover, it also has greater upside compared to Honeywell, 3M, and Danaher. GE has the strongest customer network to fully capitalize off of the global recovery.
Consensus estimates for 3M's EPS forecast that it will grow by 6% to $6.32 in 2012 and then by 9.8% and 8.9% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $6.89, the stock would hit $96.46, implying 12.6% upside. I am more reserved about ht accompany due to its exposure in consumer and office segments. In order to appropriately gain from the degree involved in those segments, I would prefer investing in companies more concretely exposed to them. 3M should consider breaking up and focusing on spurning less productive assets.
Consensus estimates for Danaher's EPS forecast that it will grow by 16.6% to $3.30 in 2012 and then by 11.8% and 12.5% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $3.61, the stock would hit $50.54, implying some downside. The Street still remains highly bullish on the company, according to NASDAQ. And the company has delivered promising momentum with high single-digit revenue growth in the core business. Perhaps most attractively, the company increased market share with strong investments in R&D. With that said, I expect outperformance from GE.