Industrial companies and stocks are clearly out of favor right now, and that's not an entirely unreasonable position - Europe continues to struggle, China and Brazil look weaker, and even the robust U.S. industrial rebound seems to be tiring. All of that bad news seem to largely be in these stocks, though, and that could make it a good time to consider shopping for diversified names like Honeywell (HON).
Growth Is Soft, But Execution Looks Very Good
On balance, Honeywell seems to be doing pretty well in the face of tougher, lower-growth conditions across many of its markets. With solid management execution showing through in the margins, I can understand why investors would look to this as a worthwhile name to hold in anticipation of a rebound.
Sales were up about 4% this quarter, with volume up 4% and price more or less flat across the board. Aerospace grew well, with revenue climbing 8%. Automation and Control saw a 2% revenue gain, while Performance Materials rose 10%. Transport, with its sizable exposure to Europe, was the only declining business (down 9%).
As mentioned, margins were solid. Gross margins were basically flat with the year-ago (and up sequentially about half a point), while corporate-level operating income rose 10%. Segment operating income climbed 14%, with only the transport business showing a year-on-year decline in operating margin.
Aerospace Likely To Glide Down A Bit
Honeywell saw quite strong original equipment orders in its commercial aerospace business, as well as strong aftermarket orders. All of this helped offset expected weaker defense sales, but sustainability could be an issue. While wide-body production rates at Boeing (BA) are going to keep General Electric (GE) and United Technologies (UTX) plenty busy, I would expect the aftermarket business to slow more to a level in line with actual flight hours (low single-digit growth recently).
ACS A "When, Not If" Business
I would suspect that business for the ACS business is not going to get substantially better this year. Other automation companies like ABB (ABB), Emerson (EMR), and Siemens (SI) have been sounding increasingly nervous about this market, particularly with the slowdowns in Europe, China, and Brazil. Likewise, there's no real momentum in residential or commercial construction or renovation to fuel expectations of a big improvement in building control.
All of that said, these are attractive markets for the long-term. Emerging market customers are keenly interested in reducing their power needs, and that is an area where Honeywell is quite good. What's more, with China apparently looking to stimulate the economy by funding more large-scale projects like refineries and regional airports, that does fit with some Honeywell's stronger capabilities in ACS.
The Bottom Line
As industrial conglomerates go, I rather like Honeywell. I wish the returns on capital were higher, and I wish the company's free cash flow conversion rates were stronger, but there's no perfect industrial stock. Relative to the likes of Emerson, Siemens, and maybe even my much-favored ABB, Honeywell looks like a quality name to own.
Valuation is just not quite there for me yet, though. Even if Honeywell can grow free cash flow at a low-teens rate for the next decade (based on abnormally low 2011; more like mid-single-digit growth on an adjusted basis), fair value tops out at around $70. That's not bad at all, but the appreciation potential is below my hurdle rate for new investments and I am more inclined towards names like GE and ABB among conglomerates or Cummins (CMI) and BorgWarner (BWA) in less-diversified industrials.