Analysis: HON WM

Shortly before the opening bell, we will be purchasing 200 shares of Honeywell (HON) at a bid/ask of $154.85/$155.29 per share. Following the trade, HON will represent 1.07% of the portfolio. We are initiating the position with a $175 price target.

We are calling up Honeywell up from the bullpen and adding it to the portfolio today. See here for our initial bullpen entry Alert.

We have been long-time fans of this name, and have been patiently waiting for a pullback because shares are trading at its all-time highs. However, during our time of closely monitoring the stock to pounce on a pullback, to our dismay the market has only pushed higher.

Since we do not want to let the market run away from us and miss an opportunity to put capital to work, we are initiating a position today to ensure that we gain stake in a great company when we can. If the market and/or the stock does lose steam, we will have plenty of cash to take advantage of any weakness.

To see Honeywell's portfolio changes presentation and its 2018 outlook (more on these below), please see here and here.

We will be following up with a more detailed initiation post on HON, but in the interim, members should know that our bullish thesis is mainly predicated on:

  • Value creation from the upcoming breakup of the company (more in the three slides below):
    • Two tax-free spinoffs of the Homes product portfolio and ADI global distribution business, and also the Transportation Systems business are expected to occur by end of 2018;
    • Remaining portfolio will contain six attractive industrial end-markets;
    • Homes and Global Distribution business will have approx. $4.5 billion in annualized revenue and be responsible for certain legacy liabilities;
    • Transportation Systems business will have approx. $3.0 billion in annualized revenue with financial responsibility for the legacy automotive segment liabilities;
    • Remaining portfolio built on segments in great positions in growing industries.
  • Expanding margins across all key segments;
  • Clean balance sheet, which gives management ample flexibility for merger and acquisition activity and/or capital returns to shareholders;
  • Great exposure to the Aerospace market that features strong industry trends and positive macro drivers;
  • Premier Free Cash Flow Generation that is targeted to grow greater than 20% in 2018, with conversion of 90% to 100%.

Portfolio Changes Presentation:

Source: Honeywell Planned Portfolio Changes Presentation

Source: Honeywell Planned Portfolio Changes Presentation

Source: Honeywell Planned Portfolio Changes Presentation

Regarding Honeywell's 2018 financial guidance, management expects 2018 earnings per share to grow between 6% to 10%, or 13% to 17% when normalized for tax. Behind the earnings per share growth is management's target of 2% to 4% organic sales growth. Management see 2018 free cash flow of $5.2 billion to $5.9 billion, with greater than 20% growth. Also of note, the company plans to buy back about $1.5 billion worth of shares in the fourth quarter, and it recently announced a 12% increase to the dividend. Below is the company's 2018 outlook by end market and by segment.

2018 Financial Guidance:

Source: Honeywell 2018 Outlook Conference Call Presentation

Source: Honeywell 2018 Outlook Conference Call Presentation

As mentioned above, we recognize that Honeywell is trading at its all-time highs, which is why we are starting off very small today. Much like our strategy with Waste Management (WM) , where we started small to leave plenty of room to scale in, we would welcome a pocket of near-term weakness before longer-term strength propels the stock forward.

We are initiating the position with a $175 price target, which reflects roughly consensus 22.5 times 2018 EPS estimates; however, we believe that Honeywell has potential for further upside on execution. Should management's organic growth and margin improvement for 2018 prove conservative, the fundamental outperformance above estimates will send the stock higher. Likewise, the upcoming breakup of the company leaves room for positive upside should management update its forecasts with expectations of additional unlocked value.