Shares of Honeywell International, Inc. (NYSE:HON) have returned 18.66% over the past 12 months. At $61.43 per share, the stock is trading just slightly off from its 52-week high of $63.48 achieved recently. Given its current attractive valuations, solid dividend yield, and robust growth potential, Honeywell International is one of my favorite dividend investments. In this article, I will elaborate the analysis that supports my bullish view for this quality stock.
Honeywell's valuations are cheap relative to the company's financial performance (see table below). Comparing to a peer group consisting of HON's comparable companies such as United Technologies (NYSE:UTX), Emerson Electric (NYSE:EMR), and Johnson Controls (NYSE:JCI), HON's strong growth and profitability prospects appear to be its primary strength.
Analysts on average predict HON's revenue, EBITDA, and EPS to rise by 2-year CAGRs of 4.0%, 42.0%, and 37.8% over the current and next fiscal years. The EBITDA and EPS estimates are significantly higher than the peer averages of 8.1% and 6.0%, respectively. In addition, HON's EBITDA margin is forecasted to expand substantially by 8.3% over the same period, compared to the average decline of 0.1% for the comparable companies.
On the profit side, although all of HON's trailing profitability margin and capital return measures are below the par, it should be noted that the expected EBITDA margin expansion of 8.3% should help boost most of the metrics down the road. In terms of leverage and liquidity, HON assumes an in-line level of debt as reflected by the company's higher debt to capitalization ratio, but lower debt to EBITDA rate.
Honeywell's trailing free cash flow margin is on par. However, the company's interest coverage ratio is currently below the peer average. But again, with the company's expected profitability improvement, that ratio should also see an increase in the near term. Both HON's current and quick ratios are above the peer averages, reflecting a healthy corporate balance sheet.
To summarize the financial comparisons, HON's superior growth potential and profitability prospects should warrant at least a small premium stock valuation relative the peer average. Nevertheless, the current stock valuations at 7.1x forward EV/EBITDA and 13.0x forward P/E actually represent an average valuation discount of 7.3% to the peer-average trading multiples (see table above), suggesting that the stock is likely undervalued.
Moreover, HON's forward P/E multiple has been underperforming the valuation of the S&P 500 index since July 2011 (see chart below). The value discount provides further support to my view that the stock is undervalued, as HON's long-term estimated earnings growth of 10.7% is largely higher than the average estimate of 7.9% for the S&P 500 companies (according to Capital IQ data).
Honeywell currently offers a 2.4% dividend yield, which is safely backed by the company's solid stream of free cash flow and commitment to continuously raise dividends. In the past decade, the annual dividend payment in general represented only a small portion of the annual free cash (see chart below), implying that there remains ample room for further dividend growth.
Additionally, dividend per share has been raised from $0.91 in FY2006 to $1.37 in FY2011. Despite no growth in FY2010, the growth rate in the subsequent year resumed to be above the 10% level due to the recovery of the free cash flow (see chart below), reflecting a sound dividend policy.
From a dividend perspective, HON is downside protected by the expected dividend growth. According to the 5-year dividend yield chart shown below, HON's yield has been hovering around 2.5% most of the time since 2010, and as long as the yield rose to higher levels, strong demand from income investors drove it down subsequently. Owing to the current low-interest market environment, I believe this pattern may persist for a while.
As such, assuming a target dividend yield at 2.5%, and supposing that the current annualized dividend per share of $1.49 would be raised by only 10% to $1.64 in 2013, that conservative scenario would imply a stock value of $66, suggesting limited downside risk.
Taking the peer-average forward P/E multiple of 13.6x, which is consistent with the current P/E multiple of the S&P 500 index, and assuming the company's EPS could rise to the analysts' average FY2013 estimate of $4.97, the 1-year target price can then be calculated to be $68, representing 10% upside. It should be noted that the calculation here is relatively conservative, given that HON should deserve a higher P/E multiple for its superior growth forecasts.
In conclusion, in the light of the cheap valuations and the solid dividend growth prospects, HON should warrant your buy decision.
Comparable analysis table is created by author, all other charts are sourced from Capital IQ, and all financial data is sourced from Morningstar and Capital IQ.