Analysis: HON AMZN

On Friday before the opening bell, Honeywell (HON) reported a top and bottom line beat with its fourth quarter result. Revenues of $9.729 billion (up 5% year over year ex spins) topped the consensus of $9.7 billion, and adjusted earnings per share of $1.91 (up 12% year over year ex spins) exceeded the consensus of $1.89.

Honeywell delivered a strong quarter and shares are outperforming today in reaction to the print. Organic sales increased 6% in the fourth quarter and full year 2018. Segment margins increased 80 basis points to 20.1% in the quarter, and full year segment margins expanded by 60 basis points. Additionally, free cash flow in the quarter was $1.5 billion, representing a conversion rate of 105%. For the full year 2018, adjusted free cash flow was $6.0 billion with 100% conversion. Perhaps what is most impressive about the free cash flow is that as a percent of sales, it was the highest it has been in 15 years. CEO Darius Adamczyk continues to excel in execution of his road map.

"We have good momentum exiting 2018 after an exciting year," said Adamczyk in the earnings release. "We continue to transform the portfolio, as we demonstrated with the successful spin-offs of our Homes and Transportation Systems businesses. We now have a simpler, more focused portfolio spread across six attractive end markets with approximately 60 percent of the portfolio growing sales at or above 5 percent organically for the full year. We effectively deployed capital to dividends, capital expenditures, acquisitions, and repurchases of Honeywell shares. Our dividend increase in September marked the ninth consecutive double-digit increase since 2010."


Aerospace revenue was $3.428 billion, topping expectations of $3.336 billion. Organic sales growth was 10%, representing the second quarter in a row in double-digit territory. Meanwhile, segment margins improved by 50 basis points to 23.4%. Within the segment, on an organic basis, sales increased 8% in Commercial Aviation OE, 5% in Commercial Aviation Aftermarket, and 17% in Defense and Space.

Breaking down the results further, the 17% increase in organic sales in defense and space featured double-digit growth in both the U.S. and International businesses, driven by global demand for sensors and guidance systems, original equipment shipment volumes and higher spare volumes on Department of Defense Programs. Commercial OE organic sales growth of 8% was driven by increased HTS engine demand for Gulfstream and Textron 1 to 2 platforms and higher aviation ships at volumes.

Honeywell Building Technologies

Honeywell Building Technologies (HBT) revenue was $1.802 billion, which was in line with the $1.819 billion expectation. Organic sales increased by 1%, and the segment margin expanded by 100 basis points to 18.6%. Within the segment, on an organic basis, Homes sales increased 6% while Buildings was flat.

Breaking the numbers down further, the segment's increase in organic sales was driven by continued demand for commercial fire products in North America, Europe, and High Growth Regions. Of note, the HPS projects backlog is up 15%. What dragged sales down in the quarter was Honeywell's air and water business in China as well as temporary supply chain challenges within building management systems. Honeywell expects air and water to recover in 2019 thanks to new product introductions for the mid-segment and the normalization of inventories.


Performance Materials and Technologies (PMT) sales of $2.802 billion was light compared to the $2.95 billion consensus as organic sales growth was flat. Segment margins improved 200 basis points to 23.3%. Within the segment, organic sales increased 2% in UOP, were up 1% at Honeywell Process Solutions, but declined 3% at Advanced Materials.

Breaking the numbers down further, Process solutions saw strong demand in its software maintenance and migration services and steel devices. Supply chain challenges within shorter-cycle components partially offset those gains. Although the weak fourth quarter macro environment may have delayed customer investment decisions, Honeywell ended the year with total orders up double digits and short-cycle backlog up over 30%.


Safety and Productivity Solutions (SPS) sales was $1.697 billion, topping the consensus of $1.602 billion. This fast-growing segment showed off double-digit organic sales growth once again, as the 15% increase in the fourth quarter represented an acceleration to the 12% third quarter number. Meanwhile, segment margins improved as well, up 30 basis points to 16.0%. Breaking the segment down further, on an organic basis, Safety sales increased by 5%, and Productivity Solutions increased by an outstanding 23%.

Breaking this high growth segment further, Intelligrated, the company's warehouse automation business, saw double-digit organic growth with a backlog conversion fueled by e-commerce. Year over year, orders in Intelligrated increased 30%. Remember, Amazon (AMZN) is a key customer of Honeywell's warehouse automation business, and increased investment by the retail/cloud-computing giant represents a tailwind for Honeywell. Honeywell also benefited from demand for Android-based mobility offerings and handheld printing devices. In China, SPS grew double digits with growth across industrial safety, productivity products, and SIoT.


For the first quarter of 2019, management expects sales in the range of $8.4 billion to $8.6 billion (consensus $8.697 billion) with organic sales growth of 3% to 5%. Earnings per share is expected to be between $1.80 and $1.85, which surpasses the consensus of $1.79 at both ends. 

For the full year 2019, management expects sales in the range of $36 billion to $36.9 billion, which is a shade light of the $37.07 billion consensus. Organic sales growth is expected to be between 2% and 5%, and management expects to hit the upper end of this range. At first glance, this outcome would represent a deceleration from 2018's +6% year, however, the guidance includes some caution due to the uncertain macro and current unpredictability in short-cycle revenues. We believe this is just conservatism and we expect management to raise the low-end range as we move through the year.

By division, management expects organic growth in Aero to increase by mid-single digits; HBT to grow low single digits, PMT to increase low single digits; and SPS to grow mid-single digits. Segment margin is expected to be between 20.7% and 21%, representing an increase of 30 to 60 basis points ex-spins. Adjusted Free Cash Flow is expected to be between $5.4 billion and $6.0 billion with a conversion rate between 95% and 100%. Lastly, earnings per share is expected to be between $7.80 and $8.10, representing an increase of 6% to 10% year over year excluding the spinoffs. At a midpoint of $7.95, Honeywell's forecast exceeds the consensus of $7.86 and is only 6 pennies below 2018's total. Based on management's track record of beating the numbers, it is reasonable to suggest that Honeywell will have an up earnings year even with the dilution from the spinoffs.

Overall, we believe the strong quarter capped off a terrific year for the company. Aerospace continues to outpace expectations, and the growth at Productivity Solutions remains rapid. Although PMT lagged in the quarter, we expect tailwinds to occur this year as refiners invest in their capabilities in order satisfy the world's growing demand for cleaner transportation fuels (IMO 2020). Regarding tariffs, management reiterated how they do not expect a significant impact in 2019, however if a trade deal occurs, we expect shares to rise given the company's exposure to the region.

As Honeywell heads into the 2019, the first full calendar year post spins, we believe the company is set up for success. Behind the 2018 transformation year which featured two spinoffs, Honeywell improved the focus of its six end markets; increased its long-cycle exposure in attractive segments, and these carry a higher degree of visibility and are more predictable compared to current short-cycle uncertainty; and has reduced the cyclicality of the portfolio. When we combine these favorable traits with overall strong organic sales growth, improving margins and free cash flow, and a clean balance sheet with plenty of optionality (management has the ability to deploy over $14 billion of cash through M&A, capex, dividends, and buybacks), we think the stock is well deserving of a greater premium to peers. We reiterate our ONE rating.