I thought Honeywell (HON) was one of the best multi-industrial companies for 2018, and although it wasn’t the best performer (Roper (ROP) did better, to name one), I’m basically happy with the modest outperformance it delivered. Looking into 2019, I still have this as one of my top names, given its healthy exposure to longer-cycle sectors like aerospace and its relatively positive end-market mix. With growth opportunities across its existing businesses and more capital deployment options, this looks like a good long-term holding that still has some shorter-term undervaluation to add to the appeal.
Basically On-Target In The Fourth Quarter
There weren’t many surprises in Honeywell’s fourth quarter, which is fine given that an above-average level of performance was expected and largely delivered.
Revenue rose 6% in organic terms, more or less matching expectations. Aerospace generated 10% organic growth (about 3% better than expected), with strong growth in defense (up 17%) and respectable growth in commercial (up 8% in original equipment and up 5% in aftermarket). Building Technology was up just 1% on flat performance in Buildings, and came in a little below expectations. Safety and Productivity was up a strong 15% (6% ahead of expectations) on 23% growth in Productivity, pushed by double-digit growth in Intelligrated. Performance Materials had a lackluster performance, with flat revenue (missing by 5%) as slight growth in UOP and Process offset weakness in Advanced Materials.
Honeywell did well on the price/cost mix, and margins also benefited from last year’s spin-offs. Gross margin improved 40bp, and while segment profits declined more than 6%, margin improved by 80bp. Aero and Building Tech were not surprisingly down in terms of earnings (with the spin-offs), but margins improved 50bp and 100bp respectively, while SPS and PMT saw 30bp and 200bp, respectively, of margin improvement.
Relative Performance And Guidance Suggest A Little Caution, But No Real Worry
Although Honeywell did alright in the fourth quarter, it wasn’t a flawless performance and guidance left the door open for some weakness as the year develops.
In the Aero business, the 10% organic growth figure was certainly decent relative to expectations, but Parker-Hannifin (PH), Eaton (ETN), United Technologies (UTX) and GE (GE) all posted higher growth rates (ranging from 12% to 22%). Management’s guidance for mid-single-digit growth in 2019 (or better) would seem to leave some room for upside, and I expect aerospace and defense to be relatively attractive end-markets for 2019.
Honeywell’s 5% growth in Safety wasn’t all that exceptional next to 3M’s (MMM) performance (up 7% in personal safety), and the company’s Building performance was likewise not so impressive next to Ingersoll-Rand’s (IR) commercial HVAC results nor Siemens (OTCPK:SIEGY) comparable segment performance. I found management’s guide for low single-digit growth in Building to be a credible outlook, as I think non-residential will slow in 2019 (in keeping with comments from others like Kone (OTCPK:KNYJY).
Automation was pretty mixed, with Emerson (EMR), Rockwell (ROK), and Siemens all outperforming, though Yokogawa didn’t do as well. Specific end-market exposures can explain at least some of this, with companies like Rockwell better leveraged to more attractive markets like food/beverage and pharma (areas Honeywell is targeting for growth), and management did comment that oil price weakness may have “temporarily delayed” some investment decisions.
All told, Honeywell management was generally more cautious on short-cycle businesses while expressing some confidence in longer-cycle businesses like aerospace. That matches my outlook going into 2019, and I think management was wise to lower expectations for some of its industrial and non-residential operations, particularly industrial businesses more exposed to weakness in electronics, China, and so on.
I don’t see 2019 as an especially great year, but Honeywell should still grow (on an adjusted/organic basis), and there are still positive drivers across the company’s businesses. Aerospace is still leveraged to healthy commercial order books and market share growth, while the automation business is moving into some new opportunities in hybrid and batch automation that should grow the addressable market. I’m also still quite bullish on the longer-term opportunity in warehouse/logistics automation. There are also a lot of smaller wins I see for Honeywell, like its Solstice commercial refrigerant business.
Longer term, I like Honeywell’s post-spin mix, and management is clearly looking to put more capital into M&A. It doesn’t sound as though the company is looking to acquire a brand new vertical (which is likely for the best), but I would think aerospace, building tech, and automation could all see more M&A activity.
Nothing is really changing in my outlook, and I still expect core long-term revenue growth in the 3% to 4% range and core FCF growth in the 4% to 5% range. Honeywell shares aren’t cheap on a discounted cash flow basis, with an implied return in the mid-to-high single-digits, but the shares do still look undervalued on EV/EBITDA, and I think the shares are priced for modest outperformance in 2019, with possibly more upside if the “general industrial” environment deteriorates further.
The Bottom Line
Honeywell isn’t the cheapest multi-industrial, and given its strong performance I’d be surprised if it were. In terms of paying up for quality, I think investors are still getting a decent value on balance with Honeywell, and it’s still a name I’d be happy to own at this point.
Disclosure: I am/we are long MMM. 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.