Honeywell International - Stock Analysis

In this Honeywell International Stock Analysis, I look at whether HON is currently an attractive investment opportunity.

One of HON's competitors in the Performance Materials and Technologies space is Emerson Electric (EMR); I recently analyzed EMR in a guest post at Dividend Power. EMR appeals to many investors because of 65 consecutive years of dividend increases.

Campbell Soup is another company I recently reviewed. This is another company that appeals to investors because of its attractive dividend yield. Based on my analysis, however, this is not a company in which I would consider investing.

Many investors are drawn to a company because of its:

  • attractive dividend yield;
  • long track record of annual dividend increases.

In my opinion, focusing on these two metrics is not a good method by which to select companies in which to invest.

I often see discussions on social media in which investors disclose their recent purchases. In many cases, the investments are of substandard quality and expose investors to a permanent capital impairment; the debt rating of some of these investments is a non-investment grade (speculative or highly speculative).

It is important to remember debt investors rank in priority to equity investors. As a result, equity carries an even greater risk than the debt ratings suggest.

HON is a high-quality company so the risk does not lie in it defaulting on its obligations or its inability to adequately cover its share buybacks and quarterly dividend payments. The risk lies in whether its current valuation is reasonable; there is a diminished probability of generating a satisfactory investment return if investors disregard valuation.

Information Sources

The following are links to my sources to aid in your own analysis.

Part 1 of the FY2020 10-K has a good overview of HON's major businesses, customers, business strategy, solutions and risks. Additional information is also available in the:

Honeywell International - Stock Analysis - Business Overview

An overview of the company's history is found here.

On October 1, 2018, HON completed the spin-off of its Transportation Systems business, formerly part of Aerospace. It also completed the spin-off of its Homes and Global Distribution business, formerly part of Home and Building Technologies on October 29, 2018. Following the spin-off of the Homes and Global Distribution business, the Home and Building Technologies segment was renamed Honeywell Building Technologies.

HON now manages its global business operations through four segments:

  • Aerospace;
  • Honeywell Building Technologies;
  • Performance Materials and Technologies; and
  • Safety and Productivity Solutions.

Please refer to the FY2020 10-K to quickly learn more about HON.

Honeywell Forge

Honeywell Forge is Enterprise Performance Management Software-as-a-Service that features connected software and hardware solutions and offers 5 core enterprise performance management applications. It measures, optimizes and automates operations, as an open, extensible, cybersecure offering designed to work across any enterprise.

Honeywell Forge solutions enable companies in the aerospace sector to turn data into predictive maintenance and predictive analytics to enable better fleet management and make flight operations more efficient.

These solutions enable building technologies customers to digitally manage buildings. Data is connected from different assets to enable smart maintenance, improve building performance and even protect from incoming security threats.

Honeywell Forge's cybersecurity capabilities help identify risks and act on cyber-related incidents thus improving operations and protecting processes, people and assets.

On the safety and productivity front, Honeywell Forge solutions digitally automate processes to improve efficiency while reducing downtime and safety costs.

Acquisitions and Divestitures

HON's growth is organic and via acquisitions; it leverages its strong balance sheet and deploys capital to high-return opportunities.

In December 2020, HON announced its intent to acquire quality management software leader Sparta Systems for ~$1.303B. This acquisition closed February 12, 2021, and is expected to further strengthen HON's leadership in industrial automation, digital transformation solutions, and enterprise performance management software. The business is included within the Performance Materials and Technologies segment.

On March 15, 2021, HON completed the sale of its retail footwear business in exchange for gross cash consideration of $0.23B. HON recognized a pre-tax gain of $90 million which is recorded in Other (income) expense. The retail footwear business was previously included in the Safety and Productivity Solutions segment.

In March 2021, HON announced the acquisition of a majority stake in Fiplex, a leading provider of in-building communications systems.

Proposed Quantum Computing Business Spin-Off

HON's CEO has been driving HON to boost profits by incorporating more software in its aerospace, automation, and natural-gas processing businesses.

In early June 2021, HON announced plans to spin off its quantum computing business and merge it with Cambridge Quantum Computing Ltd., a London-based specialized software firm. HON will own a 54% stake and Cambridge will own 46% in the joint venture.

It has committed to investing up to $0.3B in the new company; there is a possibility the new company may seek to go public.

HON scientists have been working for roughly a decade with tools from HON's energy and aerospace units to build a quantum computer. This type of computer could be vastly more powerful than traditional computers. The race to build such a computer pits HON against several startups and tech giants including International Business Machines Corp. and Alphabet Inc.’s Google.

The spinoff is designed to capture investors who want to invest early in a quantum-computing venture in an industry that could grow to $1 trillion in revenue over the next three decades as the technology improves. Such investors are not necessarily the same type of investors who invest in HON.

The spinoff lowers HON's risks if the project does not work out. It does, however, reduce the upside if the quantum-computing business takes off as promised. In a March webcast, HON stated its quantum computing business could be worth $150B within a decade.

The combination, yet to be named, is expected to be completed in Q3 2021 and HON will become a large customer of the new company.

Honeywell Ventures

In Q1, HON made five strategic investments through Honeywell Ventures. Honeywell Ventures invests in early-stage, high-growth companies from around the world that have emerging and disruptive technologies. More details can be found here.

Honeywell International - Stock Analysis - Financials

Q1 2021 Results and FY2021 Guidance

In the Q1 earnings call with analysts, management indicates there are promising signs of a rapid recovery in some of HON's markets. A high-level overview of HON's Q1 results is found in its April 23, 2021 Earnings Release.

HON generated a Q1 EPS of  $2.03 with an adjusted EPS of $1.92. This is down 13% YoY but is $0.09 above the high end of the previously provided guidance range.

Operating Cash Flow (OCF) Free Cash Flow (FCF)

HON's FY2011 - 2020 OCF was $2.833B, $3.517B, $4.335B, $5.08B, $5.519B, $5.498B, $5.966B, $6.434B, $6,897B, and $6.208B.

FCF during the same timeframe was $2.035B, $2.633B, $3,388B, $3.986B, $4.446B, $4.403B, $4.935B, $5.606B, $6.058B, and $5.302B.

OCF and FCF in Q1 (page 6 of 116 in the Q1 2021 10-Q) are $0.978B and $0.757B (OCF minus $0.221B in expenditures for property, plant and equipment).

HON consistently generates ample OCF and FCF and FY2021 FCF guidance is $5.2B - $5.5B; this range is similar to prior-year levels.

Honeywell International - Stock Analysis - Credit Ratings

In my Campbell Soup post, I noted that its long-term unsecured credit rating has been cut 8 notches in a span of ~20 years! In addition, I express concern that in August 2008, Moody's upgraded CPB's rating to A2 from A3 but in late 2014, the rating was once again cut to A3. This rating was subsequently cut 2 notches to Baa2 in early 2018.

I go on to say that although I invest in companies with similar ratings as CPB's Baa2 rating, the deteriorating trend together with several other factors leads me to conclude this is not a company in which I am prepared to invest.

In the case of HON, Moody's rated the company's senior domestic unsecured debt at the AAA level until August 1998. By August August 1989, after 3 rating downgrades, this rating had plunged to Baa2. Unlike CPB, HON addressed the deterioration in its credit rating. By October 1996 the credit rating had increased 3 times to A2; this rating has been constant since the October 1996 upgrade.

In the case of S&P Global, HON's senior domestic unsecured debt A rating has been in place since December 1992.

Fitch downgraded HON's senior domestic unsecured debt from A+ to A in August 2008 and this rating is unchanged since such time.

All 3 current ratings are the middle tier of the upper-medium investment-grade category.

These ratings define HON as having a STRONG capacity to meet its financial commitments. HON, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Honeywell International - Stock Analysis - Dividends and Share Repurchases

Dividend and Dividend Yield

FY2018 is somewhat of an anomaly in HON's dividend history in that it distributed 2 special dividends (September and October)  related to the spin-offs of the former Transportation Systems business (formerly in Aerospace) and the former Homes and ADI Global Distribution business (formerly in Honeywell Building Technologies).

If we exclude these special dividends we see that HON's quarterly dividend has increased annually as follows.

HON - 11th Dividend Increase Since 2010

HON's current $0.93 quarterly dividend yields ~1.75% based on the current $212.50 share price. This yield may not appeal to many investors. However, I much prefer to invest in a company whose cash flow and earnings support the dividend versus a company where the sustainability of the dividend is questionable.

In the case of HON, the dividend is sustainable.

Stock Splits and Share Repurchases

HON initiated 2 for 1 stock splits in 1994 and 1997.

In April 2019, HON's Board of Directors authorized the repurchase of up to a total of $10B of HON common stock. Approximately $3.3B and $7B remained available as of December 31, 2020 and 2019 for additional share repurchases.

HON repurchased ~20.7 million and ~26.5 million shares of its common stock during FY2020 and FY2019 for $3.714B and $4.4B.

On February 12, 2021, HON's Board of Directors authorized the repurchase of up to a total of $10B of HON common stock. This includes and replaces amounts remaining under the previously approved share repurchase program. In Q1, HON repurchased $0.822B of common stock.

The FY2011 - 2020 average shares outstanding are (in millions of shares): 792, 792, 797, 795, 789, 775, 772, 753, 730, and 711.

The weighted average diluted shares outstanding at the end of Q1 2021 is 696.2 million plus 8.3 million of dilutive securities issuable under HON's stock plans for a total of 704.5 million.

Honeywell International - Stock Analysis - Valuation

In Q1 2021, HON generated $2.03 in diluted EPS and $1.92 in adjusted diluted EPS.

Management has increased FY2021 adjusted diluted EPS guidance from $7.60 - $8 to $7.75 - $8. With shares trading at ~$215.50, the forward adjusted diluted PE is ~27.37 using the $7.875 mid-point of management's guidance.

Guidance from the 22 brokers which cover HON is fairly wide-ranging.

  • FY2021 adjusted diluted EPS is a mean of $8.01 and a $7.90 - $8.10 range. With shares trading at ~$215.50, the forward adjusted diluted PE is ~27 using the mean value.
  • FY2022 adjusted diluted EPS is a mean of $9.09 and an $8.70 - $9.65 range. With shares trading at ~$215.50, the forward adjusted diluted PE is ~23.7 using the mean value.

HON's FY2011 - 2020 diluted EPS are $2.61, $3.69, $4.92, $5.33, $6.04, $6.21, $2.00, $8.98, $8.41, and $6.72.

Its GAAP diluted PE level over the same timeframe is 16.67, 17.20, 22.62, 18.78, 18.14, 18.13, 23.24, 37.22, 20.68, and 30.52.

HON is a high-quality company but it becomes difficult to generate a reasonable return when the valuation is excessive.

I think an adjusted diluted PE below 25 is more appropriate. Using this level and the $7.875 mid-point of management's guidance, a price closer to ~$195 is a level at which I would consider initiating a position.

Honeywell International - Stock Analysis - Final Thoughts

I continue to expect a significant broad market pullback and 'when the tide goes out will we discover who has been swimming naked.' [Warren Buffett]

When I compare HON versus CPB, I can not see any justification for an investment in CPB. Some investors, however, may view CPB as a better investment alternative because of its dividend yield. However, investing in a company based on dividend metrics is a flawed method by which to make an investment decision.

I prefer to look at an investment's overall potential return, the degree of risk, and the company's growth prospects.

In my opinion, HON is a far better company than CPB and EMR. My issue with HON is the valuation. I am, therefore, in no rush to acquire shares and will patiently wait until its valuation becomes more reasonable.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I do not have exposure to HON and intend to initiate a position when shares retrace to the mid $190 level or lower.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.