Honeywell (NASDAQ:HON) is a core holding in the R.I.P. portfolio, and the stock has performed well over the last 3 plus years. More recently, however, HON shares have underperformed the broader market by over 6 percentage points.
The recent underperformance for HON shares has created a long-term buying opportunity because, in my opinion, this industrial conglomerate is well-positioned for 2019 and beyond. Moreover, the recent spins could potentially be a major catalyst for the HON shares in the current year.
In late 2018, Honeywell spun off its Transportation Systems business, Garrett Motion (GTX), and its Homes and Global Distribution business, Resideo (REZI). If investors remember correctly, Honeywell's management team remained believers in the long-term business prospects of both spin-off companies, but, as they put it, Honeywell is better positioned without the two businesses in the fold. It is a classic case of addition by subtraction. For example, Honeywell raised its full-year 2018 guidance after the spin-offs were announced.
Source: 2018 Outlook Presentation
The spins will not only allow for Honeywell to allocate capital in a more efficient manner to core businesses but, more importantly, they will also give Honeywell the potential to return a tremendous amount of capital to shareholders.
In addition, Garrett Motion and Resideo entered into agreements related to legacy liabilities, so Honeywell's management team will be able to better manage/plan for future expenditures. Simply put, Honeywell is better off without Garrett and Resideo. Honeywell's business has been transformed, and, if you ask me, the company is better positioned for 2019 and beyond. It helps that the recent results (and guidance) support this thought.
Full disclosure: I hold positions in both Garrett Motion and Resideo in the R.I.P. portfolio.
Honeywell has a track record for beating expectations, as shown by the fact that the company has beat the consensus EPS estimate in six out of the last eight quarters.
Honeywell's recent results were more of the same. The company reported better-than-expected Q3 2018 EPS of $2.03 (beat by $0.04) on revenue of $10.76B (in line with analyst estimates). The company's Q3 2018 financial results were also significant improvements from what Honeywell reported in the year-ago quarter (revenue and adjusted EPS were up 7% and 17%, respectively).
Source: Q3 2018 Earnings Presentation
And more importantly, management raised their full-year guidance for the fourth time over the last year:
Source: Q3 2018 Earnings Presentation
There was a lot to like about Honeywell's fiscal 2018 results so far (the Q4 2018 results are expected to be released on February 1, 2019) but, in my opinion, 2019 has the potential to be an even better year from an operational standpoint.
The long-term bull story for Honeywell has not changed: this conglomerate has great businesses in industries that have promising long-term prospects. Moreover, Honeywell appears to have the right management in place and its focus on software (i.e. Industrial Internet of Things) is already paying huge dividends. Lastly, this company should continue to benefit from the strong tailwinds within aerospace.
Most economists think that GDP will slow in 2019 when compared to 2018, and current estimates are for GDP growth to remain above 2%.
GDP growth will likely not be as high as the past 12 months, but many experts are guiding for stocks to perform well in the new year. Additionally, many pundits are concerned about equities at this point in time, but, as reported by Nuveen, stocks have actually performed well in environments similar to what we are in today.
Source: Nuveen, Fall 2018 Report
At the end of the day, I believe that Honeywell will benefit from a promising backdrop. The economy is not on fire, but, in my mind, Honeywell operates in industries that have strong tailwinds (most notably, Aerospace and Performance Materials & Tech.). Moreover, analysts expect for the companies of the S&P 500 to report strong earnings growth for Q4 2018, after reporting impressive 20% growth in each of the last 3 quarters, so stocks should see some upward movement in the near term, barring weaker-than-expected guidance for 2019.
Source: FactSet, January 7, 2019, Report
Industrials (including Honeywell) will likely be punished if the U.S. has a major economic slowdown, but, in my opinion, a recession is likely not in the cards over the next 12 months.
Honeywell's stock is trading at an attractive valuation at today's price.
17x forward earnings is not cheap, but I believe that Honeywell is in a position to outgrow its current valuation. Specifically, I have a 12-18-month price target of $160 per share; so, in my opinion, HON shares are attractively valued at today's level.
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.
Additionally, Honeywell disclosed that the SEC opened an investigation into its accounting for asbestos-related liabilities. Management recently increased its estimate for the potential liabilities for these liabilities, so the SEC is looking into the previously communicated (and booked) estimated charges. I view this as noise, but obviously, it is never good when the SEC comes knocking.
This company may not get a ton of coverage, but Honeywell is indeed firing on all cylinders. The company is better positioned today than it has been in years, and, in my opinion, the stock is trading at an attractive valuation (the Street agrees - see this recent upgrade). As such, I believe that investors should treat any significant pullbacks, especially if they are caused by broader market concerns, as long-term buying opportunities.
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.
This article was written by
Disclosure: I am/we are long HON, GTX, REZI. 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.