Another Reason To Own Honeywell: A Deeper Dive Into The Upcoming Spinoff

Summary

• Honeywell was already a must-own company/stock, but in my opinion, the spinoffs are another reason to own the company's shares today.
• There is a lot to like about the upcoming spinoff, Garrett Motion Inc. However, investors need to consider several major risk factors.
• I plan to hold onto my Garrett Motion shares once the company gets spun out. What are your thoughts on this soon-to-be standalone entity?
• Members of my private investing community, Going Long With W.G., can follow this idea, as well as my other top picks with access to my model portfolio. Start your free trial today >>

I recently published a bullish article on Honeywell (NASDAQ:HON) and described why investors should stick with this "winning" company. As described in the linked article, Honeywell is well-positioned for 2018 (and beyond), and the company's recent operating results fully supports the bull case for this industrial conglomerate.

In this article, I will describe another reason why investors may want to stay invested in Honeywell through at least the end of 2018, i.e., the upcoming spinoffs, and more specifically, the Garrett Motion (NASDAQ:GTX) spin that will occur in the near future.

Garrett Motion - A Lot To Like Here

Honeywell announced that its board declared a pro rata dividend of stock in Garrett Motion Inc. that will be made on October 1, 2018, to Honeywell shareholders as of September 18, 2018 (the record date). According to the company, shareholders will receive 1 share of Garrett Motion for every 10 shares of Honeywell common stock that is owned. And finally, Garrett Motion will begin regular-way trading on the NYSE under the symbol "GTX" on October 1, 2018.

With the transaction details out of the way, let's focus on what shareholders will receive in early October. During the Garrett Investor Conference that was held on September 6, 2018, management did a great job describing the soon-to-be standalone company's business, financial position, cost structure and investment thesis.

Shareholders/prospective investors should definitely review the entire Investor Presentation, but I will provide my top three takeaways below. However, before we jump in, the following is Garrett Motion's business overview from the recently released Form 10:

Our Company designs, manufactures and sells highly engineered turbocharger and electric-boosting technologies for light and commercial vehicle original equipment manufacturers (“OEMs”) and the aftermarket. We are a global technology leader with significant expertise in delivering products across gasoline, diesel, natural gas and electrified (hybrid and fuel cell) powertrains.

Our products are highly engineered for each individual powertrain platform, requiring close collaboration with our customers in the earliest years of powertrain and new vehicle design. Our turbocharging and electric-boosting products enable our customers to improve vehicle performance while addressing continually evolving and converging regulations that mandate significant increases in fuel efficiency and reductions in exhaust emissions worldwide. Market penetration of vehicles with a turbocharger is expected to increase from approximately 47% in 2017 to approximately 59% by 2022, according to IHS and other industry sources, which we believe will allow our business to grow at a faster rate than overall automobile production.

Garrett operates in a highly cyclical industry, and it is subject to significant currency risk (two significant risk factors), but in my opinion, there are legitimate reasons why investors may want to hold onto GTX shares after they begin to trade on the NYSE.

My Top 3 Takeaways From The Garrett Motion Investor Presentation

(1) Garrett Shouldn't Be Viewed As An Outcast

This company has global scale and it has a promising product portfolio, but more importantly, Garrett already has a solid business with strong operating results/metrics.

Additionally, it is a market leader in an industry that has promising prospects.

As shown, Garrett's top line grew organically by 7% YoY over the first half of 2018. Also shown, the company operates in areas that are expected to experience strong growth over the next 7-plus years.

It is important to note that Honeywell is not spinning off Garrett because it's a bad business, but instead, Honeywell's management team determined that Garrett would operate better as a standalone entity (coupled with the fact that Honeywell is streamlining operations). Simply put, the business makeup of Garrett (highly cyclical) did not fit the core business criteria that Mr. Darius Adamczyk, CEO, wanted for Honeywell for the years ahead. On the other hand, management has continued to talk up Garrett and its long-term business prospects.

(2) Financially, Garrett Is Well-Positioned (Sort Of)

Let's start with how the company is positioned from a financial standpoint. Garrett has a great cost structure that will allow it to weather downturns, which is especially important for a company that operates in an industry that will always have to contend with business cycles.

Garrett Motion's cost structure, coupled with its ability to effectively manage its working capital management (something that Honeywell is known for), has allowed for the company to have a superior margin profile.

From a balance sheet perspective, Garrett is in what I would call a "serviceable" position (i.e., nothing to really brag about, but nothing to cry about either).

The company will have a large net debt position, and its current ratio is below 1 (not good). As shown, the payments on the large liability to Honeywell ("Obligations payable to Honeywell") are capped on an annual basis, which somewhat limits the financial risk.

I say that Garrett is in a serviceable financial position because I believe that the company has the cash flow prospects to deleverage its stretched balance sheet in the next few years. As expected, Garrett is not being spun out with a great balance sheet, but in my opinion, management's long-term financial goals (specifically, deleveraging) are achievable.

(3) The Technology Growth Prospects Are Strong

Garrett is already well-positioned in the turbocharge space, but its management team has also been laser-focused on the next key growth driver, technology.

The company is utilizing technology to differentiate its current products/services, but more importantly, management is also heavily investing for the future. Garrett has a pipeline that has a great deal of promise, of course, in my opinion. For example, the company already has market-leading products for hybrids/electric cars, and it is laying the ground work for connected and autonomous vehicles.

I believe that connected and autonomous vehicles are the future for the automobile industry, so it is encouraging that Garrett is fully engaged and already collaborating with its customers in this space. In my opinion, technology changes for autos is both Garrett's biggest market opportunity and risk factor.

Risks

Please refer to Garrett Motion's Form 10 (linked above) for the risk factors that management identified. In my mind, the biggest risk factor is related to how technology will impact the industry that the company operates in. If Garrett falls behind or fails to meet its customers future needs - it is obviously highly dependent on the OEMs in the automobile industry (accounted for 88% of total revenue for fiscal 2017) - the stock will face a tremendous amount of downward pressure.

To this point, while the connected vehicle and autonomous cars are growth areas, a slight wrong turn (i.e., management not properly positioning the company in the ever-changing landscape) could be disastrous for Garrett's long-term business prospects.

Lastly, management being able to deleverage the company will be important over the next few years. Investors should closely monitor management's ability to achieve their long-term financial goals.

Bottom Line

Garrett Motion (and the other spinoff) is not the reason to own Honeywell, but it sure does help the bull case for the stock. Based on Honeywell's recent track record, management knows what they are doing when it comes to spinning off non-core businesses/assets - AdvanSix (ASIX) was spun out in late 2016, and the stock is already up over 100%.

Additionally, it is important to note that Honeywell's management team views Garrett as a viable (and valuable) standalone entity, but they simply determined that a more-focused and streamlined Honeywell was the best route to take. The auto industry may have already peaked for this business cycle, but it appears that Garrett is properly positioned for the future.

As a Honeywell shareholder, I plan to stay the course with both my HON shares and the soon-to-be distributed GTX shares. How about you?

Lastly, I plan to do a deeper dive into Garrett Motion once it becomes a standalone public company (especially from a valuation standpoint), so stay tuned.

Author's Note: All images were obtained from the Garrett Investor Conference (linked above), 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. 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.