A combination of operational improvements, M&A, and a relatively cheap valuation has the industrial company's shares looking more attractive than they have in years. By Al Root
After years of underperformance, Honeywell International stock may be ready to resume its winning ways.
Honeywell was once known for its consistent business -- and a consistently outperforming stock. With leading franchises, a strong balance sheet, and solid prospects, it was seen as a high-quality industrial company, worth a premium valuation. The pandemic, however, hit Honeywell hard. From 2018 to 2023, the company's earnings per share grew at an average annual rate of about 3%, below the S&P 500's 8%. Over the past five years, its stock gained just 24%, underperforming the benchmark index by some 60 percentage points.
Honeywell now looks set to get back on track. Under CEO Vimal Kapur, who took over in June 2023, the company is targeting 10% annual earnings growth, using acquisitions and operational improvement -- with an assist from postpandemic normalization -- to get there. The stock also looks reasonably priced in a way it hasn't in years. Combine that with the possibility that the pieces could be worth more than the whole, and Honeywell shares, at a recent $213, look like a bet whose time has come.
"[Honeywell] stock has underperformed quite a bit the last couple of years, and the valuation is attractive. So if we can get some work done on the portfolio, all while end-markets are recovering, that should bring interest back to the name," says Melius Research analyst Scott Davis.
Honeywell operates four business segments. The Aerospace division, which sells everything from engines and flight controls to auxiliary power units that keep aircraft systems on when the main engines aren't running, is doing great after a miserable run during Covid; it reported first-quarter sales of $3.7 billion in April, up 18% year over year. Energy and Sustainability Solutions, which serves the refining, chemicals, and power-generation industries, has returned to growth, too, with first-quarter sales of $1.5 billion, up 5% year over year.
Honeywell's Industrial Automation business, which sells masks, conveyor belts, and hand-held computers for automated warehouses, continues to struggle. First-quarter sales came in at $2.5 billion, down 13% year over year, after growing by 6% in 2020. Selling masks isn't the big business it once was, and a slowing industrial economy has hurt automation sales. The Building Automation business, which manages the systems in office buildings, still hasn't returned to normal after the Covid lockdowns. First-quarter sales, at $1.4 billion, were down 3% year over year.
Operational improvements will help boost those businesses -- and the company as a whole. Kapur is targeting 25% operating profit margins, up from 22.2% in the first quarter of this year. Wall Street isn't optimistic, which gives Honeywell a chance to surprise the Street. Another part of the improvement comes from things returning to normal. Sales in 2023 amounted to $36.7 billion, virtually the same as 2019. Analysts project annual sales growth of about 5% a year from 2023 to 2026.
"The end markets should be lining up pretty good by [year] end," says Melius' Davis. "Aerospace is likely to remain strong while we get a recovery in automation."
Honeywell is also hoping that mergers and acquisitions can provide a boost. On June 3, it closed its $5 billion acquisition of Carrier's building security business, which fits inside the Building Automation segment, boosting product offerings where the company is already a strong competitor. On June 20, Honeywell announced plans to buy defense communications company CAES for about $2 billion, adding to its aerospace business. Both deals were well received on Wall Street.
More billion-dollar M&A should be coming as Kapur positions the company for better growth -- and Honeywell has the balance sheet to make them happen. The company had just $12 billion in debt less cash at the end of the first quarter, or about 1.2 times projected 2024 earnings before interest, taxes, depreciation, and amortization, or Ebitda. Industrial companies in the S&P 500 typically operate with about two times debt to Ebitda.
"For a company the size of Honeywell, [both deals aren't] a particularly heavy lift, but it does point to an M&A program that has finally begun to put points on the scoreboard," wrote Gordon Haskett special situations analyst Don Bilson in a recent report.
With improvements happening in real time, Honeywell stock is starting to look attractive. Davis rates the shares Buy and has a $278 price target for the stock, up 30% from recent levels. That values Honeywell stock for about 22 times Davis' estimated 2026 earnings. Those estimates don't include benefits from the CAES deal.
Assuming some benefit from M&A and margins, which can help restore Honeywell's premium valuation, investors could be looking at a $300 stock in a year, up 40% from recent levels.
And if it can't get there? Don't expect investors to accept continued underperformance. Mizuho Securities analyst Brett Linzey says he is getting "increased call volume" on Honeywell, a sign that his clients are taking a new look at the stock. One reason is all the activism and breakup activity in the industrial and manufacturing space. General Electric is now three companies; DuPont de Nemours is breaking up again; and activist investor Elliott Investment Management has built a position in Johnson Controls International.
Honeywell could make an attractive target, too, based on a "sum of the parts" valuation. Valuing Honeywell's aerospace business at 20 times Ebitda -- a similar multiple to GE Aerospace -- would give it a value of some $85 billion, while its building, automation, and energy units could be worth $34 billion, $47 billion, and $25 billion, respectively. Combined, that would give Honeywell a value of $278 a share, according to Mizuho's Linzey -- the same target as Melius' Davis.
Kapur is a relatively new CEO, and likely won't want to consider breaking up Honeywell. Chances are he won't need to.
Write to Al Root at allen.root@dowjones.com
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(END) Dow Jones Newswires
June 28, 2024 21:30 ET (01:30 GMT)
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