Honeywell: As Good As It Gets

Summary

• The company's 2018 guidance was well-received by the market.
• HON is a best-of-breed industrial company that deserves a 'premium' valuation.
• HON shares are a long-term buy at today's price.

On December 13, 2017, Honeywell's (NASDAQ:HON) management team held an investor meeting where it provided the company's fiscal 2018 guidance to the financial community. The 2018 guidance and management's commentary were well-received by the market. HON shares are up only ~1% since the investor meeting, but shares are outperforming the broader market by a wide margin on a YTD basis.

Source: Nasdaq

There was a lot to like about Honeywell's 2018 guidance and, in my opinion, the bull case for this industrial conglomerate may be stronger now than it has ever been. Moreover, I believe that Honeywell is as good as it gets in the industrial space, so investors should not be worried about the company's 'premium' valuation.

The 2018 Guidance - Good, Better, Best

Many people, including myself, were worried when Mr. Darius Adamczyk, CEO, took over for Mr. David Cote in April 2017 but this company has not missed a beat over the last seven-plus months. Mr. Adamczyk has actually done an impressive job winning over the market, as shown by the fact that HON shares are up over 20% since he took over as CEO. More importantly, however, Mr. Adamczyk and team have this company in a great position in a changing industrial environment and it appears that this narrative will likely also play out in 2018.

After initially going over the material from the investor meeting, I thought that Honeywell was going to have a lackluster fiscal 2018, but after further review, it appears that management was just trying to tone down expectations. Why do I think this? It's simple. It is hard denying the fact that it appears more likely than not that the U.S. economy, including the industries that Honeywell operates in, will experience growth over the next 4 quarters. Plus, I believe that management was talking out of the other side of its mouth when it stated that several key business units were operating in very favorable environments.

For the aerospace division, management only projected for low single digit (1-3%) organic sales growth for 2018. Let's remember that most companies operating in this space are actually calling for significant growth in the years ahead (more on this below). And yes, the tax bill passing (not signed by the President, as of December 21, 2017) will bode well for Honeywell and its business prospects. At the end of the day, I believe that the lackluster 2018 guidance was simply management trying to set the company up for success in the new year. Remember, the market is overly bullish on Honeywell so any type of setback (i.e., analyst estimate miss) will significantly impact sentiment.

There was way too much information shared to cover in just one article, so I will spend a few minutes on what I considered the 3 most important points that management made during investor meeting.

1) Good - A Strong Finish To 2017

The company guided for a strong finish to the current year. For Q4 2017, management expects to report organic sales growth in the high single-digit range and earnings per share to reach ~$1.84 (up from the $1.74 that was reported in Q4 2016).

As shown, management also expects to reach the high end of its earnings guidance for full-year 2017, which would translate into ~10% YoY growth for adjusted EPS. Furthermore, Honeywell's improvements in generating cash have not been highlighted enough, as management guided for FCF to be in the range of 5%-7% for full-year 2017. Simply put, this company is projected to cap off a great year with a strong Q4 earnings report.

2) Better - A Great Outlook For 2018

Next year's guidance is more important than the Q4 2017 results, in my opinion, so it is encouraging that management expects to keep the impressive momentum going through 2018. Management guided for both sales and earnings to grow over the next four quarters, in addition to a nice uptick in margins.

These estimates, including the only 2-4% sales growth, are impressive when you consider the backdrop. Fx and restructuring costs are likely to be headwinds over the next 12 months but these factors are not enough to derail the company. In my mind, it is encouraging that management anticipates for the prospects of oil and gas industry to improve in 2018, at least as it relates to the company's operations, because Honeywell's O&G division has been a major drag on the consolidated results. 2018 is shaping up to be a game-changing year for Honeywell. But, it gets better.

3) Best - A Promising Capital Return Story

The most important takeaway from Honeywell's investor meeting, of course, in my opinion, was the capital return numbers that are being thrown around.

Honeywell recently announced that its board authorized a new $8B buyback program, which is on top of the already $1.5B that is remaining from a previous program. This is a material buyback announcement because it would allow for the company to repurchase almost 7% of the total shares outstanding. Let's also remember that Honeywell recently increased its dividend by 12% a few months ago.

This company's capital return story is not only about buybacks or dividend either, as management expects to also focus on finding strategic acquisitions. Plus, as management described, the tax bill passing will be a positive development for Honeywell's capital deployment plans for 2018.

Putting It All Together

What's not to like about a company that: (1) guided for a strong finish to 2017, (2) expects to report impressive top- and bottom-line growth over the next 12 months, and (3) has a capital return story that has legs? Honeywell has shown over and over again that its bull case is intact and, in my opinion, the company's story actually keeps getting better.

To start, getting back to the Aerospace division, I believe that this operating unit will greatly contribute to Honeywell meeting analysts' estimates in 2018. This division has several significant tailwinds that should allow for it to continue the substantial growth that it has reported in the recent past. Honeywell is a key supplier to many players in this industry so it will do well when others are doing well. For example, Boeing (BA) (a major customer) is forecasting for significant growth for its business over the next few decades.

Source: Boeing's Current Market Outlook 2017-2036

In addition to the commercial growth, Honeywell has a defense business that recently reported 7% YoY growth in its backlog. The defense businesses of Honeywell's aerospace portfolio is not the only operations that are performing well, as the company is also building momentum in Commercial Aviation. While Honeywell is projecting for only a “modest pace for near-term orders due to an uncertain economic and political environment along with a very competitive used aircraft market" for the business jet aviation industry, current forecasts are for 8,300 new business jets worth $249B to be delivered from 2017 to 2027.

Source: Honeywell's October 2017 Press Release

The improving prospects in almost all areas of the aerospace segments, including the digital space (i.e., Connected Aircraft), should allow for this operating unit to keep the substantial sales growth going through 2018 and beyond. Moreover, management has implemented several cost-cutting initiatives that are directly contributing to the increasing margin for the aerospace division.

Source: Aircraft Supplier Conference, September 2017

And it gets better because, in addition to the aerospace division, management has recently pulled two other levers that should create value in 2018. First, Honeywell has made several small tuck-in acquisitions that should add value to the company's business offerings that are already in high demand. The two recent examples are: (1) the 25% stake taken in the Chinese supply chain software company Flux Information Tech, and (2) the acquisition of SCAME Sistemi to bolster its connected building solutions. Both of these acquisitions may not move the needle in 2018, but looking out, these are exactly the type of assets that will bode well for the company's long-term business prospects.

Additionally, I believe that the previously announced spin-offs - the Transportation Systems & Homes And Global Distributions units - will likely turn out to be long-term catalysts for HON shares. As described in this article, the restructuring plan will allow management to unlock value, while at the same time streamline operations and focus on the company's core operations (Aerospace, Building Technologies, Performance Material And Technologies, and Safety And Productivity Solutions).

The recent investor meeting simply re-affirmed my bullish thesis for this company and it actually caused me to rethink my 12-18 month price target. Lastly, if all of this was not enough, it is important to note that HON shares are also trading at what I consider a reasonable valuation.

Valuation

Honeywell's stock is trading at a reasonable valuation based on forward earnings estimates.

HON PE Ratio (Forward) data by YCharts

At 21x forward earnings estimates, HON shares may appear overvalued but I could make the argument that this company has the best prospects out of this peer group. To this point, Honeywell reported above-average sales growth over the last 5 years and the company is projected to significantly grow earnings over the next 5 years.

	HON	UTX	MMM	GE
EPS next 5Y	8.22%	4.27%	10%	13%
Sales past 5Y	1.50%	0.50%	0.30%	-3.30%

Click to enlarge

(Source: Data from Finviz; table created by W.G. Investment Research)

This is one of the many reasons why Honeywell deserves a 'premium' valuation. Per Yahoo! Finance, Honeywell has a "Buy" rating and a price target of $165/share (7% upside from today's price). I, however, believe that Honeywell will not only grow into its current valuation but I anticipate for the company's forward estimates to get ratcheted up over the next two-to-three quarters. As such, I believe that HON shares will be trading north $175 over the next 12-18 months.

Risks

A global recession is the most significant risk to my investment thesis, at least in the near term. I do not believe that a recession is not likely to happen over the next 12 months, but if one were to materialize, Honeywell's businesses would be negatively impacted in a major way. Furthermore, investor sentiment is extremely bullish for Honeywell at this point in time and it largely revolves around the prospects for the aerospace division, so a slowdown in this industry would likely result in shares selling off.

Another risk point relates to the company's restructuring plan because there is no guarantee that the spin-offs will go without a hitch. If the company has cost buildups or issues with the formation of the two separate entities, Honeywell's stock could be under pressure in late 2018/early 2019.

Bottom Line

My biggest takeaway from Honeywell's Outlook Investor Meeting was that this company appears to be well-positioned for 2018 and beyond. Honeywell is as good as it gets if you are looking to invest in the industrial space. This company is a best-of-breed industrial conglomerate that has promising business prospects, especially if the global economy continues to improve in 2018. Additionally, there are several catalysts - tax reform bill, spin-offs, and potential infrastructure spending bill in 2018 - that are likely to play out over the next 12-18 months, so investors with a time horizon longer than 1 year should view any pullbacks as long-term buying opportunities.

Author's Note: Honeywell is a core holding in the R.I.P. portfolio, and I have no plans to reduce my stake in the near future.

Full Disclosure: All images were taken from Honeywell's 2018 Outlook Investor Meeting, unless otherwise stated.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long HON, GE. 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.