Honeywell: Stick With What Has Been Working

Summary

• Honeywell's stock has been under pressure in the recent past, but HON's shares are still significantly outperforming the broader market over the last 5 years.
• Honeywell's recent operating results (and management commentary) tell a good story about this company's long-term business prospects. As such, I believe that long-term shareholders should consider staying the course.
• I hold a sizable Honeywell position and I plan to stay long the stock.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Get started today »

Honeywell's (NASDAQ:HON) stock has faced downward pressure over the last 3 months, as shown by the fact that the broader market is outperforming HON's shares by ~5 percentage points over this period of time.

Data by YCharts

The market has been extremely volatile so far in 2019 with the biggest contributor being the US-China trade war (and related concerns), but, in my opinion, investors should look past the current noise and stick with what has been working, i.e., Honeywell's stock. HON's shares have significantly outperformed the broader market over the last 1-, 3- and 5-year periods. And if you ask me, investors should expect more of the same over the next 5 years.

The Latest - Good Results From Top To Bottom

Honeywell recently reported adjusted Q2 2019 EPS of $2.10 (beat by $0.02) on revenue of $9.24B (missed by $130M), which compares favorably to the year-ago period.

Source: Q2 2019 Earnings Presentation

As shown, Honeywell's quarterly results were strong across the board. Organic sales were up 5% YoY, which was primarily a result of strength seen in aerospace and building solutions (key growth drivers for this company). Additionally, Honeywell's adjusted EPS were higher YoY and, importantly, the company continued the long streak of improving its cash conversion.

However, as I previously described here, I believe that Honeywell's margins are the real story for this industrial conglomerate (and its stock), so it is encouraging that the most recent results showed further progress toward management's goal of eliminating unnecessary costs and expanding margins in three out of four of its operating segments.

Source: Q2 2019 Earnings Presentation

There is a lot to like about Honeywell's most recent operating results, but looking ahead, it is hard not to be bullish about Honeywell's business prospects, especially after factoring in the strong 2019 guidance.

Source: Q2 2019 Earnings Presentation

Management again raised their full-year 2019 guidance (organic sales by 1 percentage point, EPS by $0.05, and adjusted free cash flows by $0.2B) and this well-run company does not appear to be slowing down anytime soon. Looking ahead, investors should begin to bake in expectations for Honeywell to have a strong finish to the current year, which should bode well for HON's shareholders.

The CEO Is Also Telling A Good Story

In a recent interview with the Charlotte Business Journal, Mr. Adamczyk spoke at length about why he feels Honeywell is well-positioned for the future. For a majority of the interview, he talked up the company's main growth driver, Honeywell Connected Enterprise, which is the company's data-driven software portfolio:

"We’re aggressively growing our software portfolio through something called the Honeywell Connected Enterprise. It’s really our IIOT (industrial internet of things) play in the markets that we currently play in. It’s much more of a hybrid model. Yes, we provide some of the hardware in some of those end markets — that being aerospace and building technologies and warehouses — but then combining it with software to really enhance the value for the end customers.

And ultimately, I think, it’s going to be much more of a software sale than a hardware sale. Essentially what we are selling are those experiences and outcomes, which are driven by the software. And the hardware enables us to be able to run the software because much of our hardware is really sensors.

The good news for us is that one common theme across all our businesses is that we’re a controls company. So processing, analyzing data — digital data is not new to us. In fact, we have more software engineers within our ranks than any other type of employee."

And most importantly, the data driven approach is not for just one business unit, but instead, each of Honeywell's operating segments have been focusing on expanding its data footprint. This approach is beneficial because software is a high margin business, but as described by Mr. Adamczyk during the interview, Honeywell focusing on software/data will also allow for the company to better manage its earnings profile:

"Because if you are only a hardware provider, you are likely to be subject to the cycles of that industry. If you are more of a software provider, which generally has a service component tied to it, that tends to smooth out some of the cyclicality that we see in the business."

The Garrett Motion (GTX) and Resideo (REZI) spinoffs should act as catalysts as the company enters 2020. This smoothing of earnings, which will undoubtedly be a 5- to 10-year story, will be especially important when future recessions hit. Will Honeywell be immune to the next downturn? No, but I do believe that the company's new (and changing) business profile will help Honeywell weather the storms. This point of the company being a good stock to hold in a volatile market was actually recently made by Barclays when Honeywell was given a "Buy" rating with a price target of $187.

At the end of the day, Mr. Adamczyk was simply just doing his job when he highlighted Honeywell's business prospects in the software space during the Charlotte Business Journal interview, but let's also remember that the company's financial results (and operating metrics) also supports this part of the investment thesis. So yes, Honeywell's management team has a good story to tell, but it helps that the story is also verifiable.

Valuation

HON's shares are not cheap by any means, as shown by the Seeking Alpha valuation grades.

Source: Seeking Alpha

Two things to note: (1) Honeywell is by far the best run industrial conglomerate so the sector median should not be a major focus, and (2) Honeywell is now a different company, remember the spinoffs, so its earnings potential going forward is greater than it has been in the past. I say all of this to say, Honeywell's stock is not cheap but let us remember that this best-of-breed industrial conglomerate has the potential to more than grow into its current valuation.

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.

Bottom Line

Honeywell is the best-run industrial conglomerate and the company has promising long-term business prospects, especially in the industrial internet of things ("IIoT") and software space. Therefore, the investment approach is simple: stick with what has been working. Honeywell's stock has performed well for an extended period of time and I do not see this changing anytime soon.

Additionally, the SEC closing the case related to Honeywell's accounting for asbestos claims without recommending any enforcement action may turn out to be another catalyst for the stock. Investors with a time horizon longer than a year should treat HON pullbacks, especially if they are caused by broader market concerns, as long-term buying opportunities.

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.