Analysis: HON

Friday before the opening bell, Honeywell (HON) reported a top- and bottom-line beat with its third-quarter earnings. Revenues of $7.797 billion (-14% YoY and -14% an organic basis) exceeded expectations of $7.6 billion and earnings per share of $1.56 (-25% YoY) exceeded expectations of $1.49.

Looking to some other firm-wide metrics, segment margin contracted 130 basis points to 19.9% as lower volumes and margins in Aerospace and Performance Materials & Technologies more than offset margin expansion in Honeywell Building Technologies and Safety & Productivity Solutions as well as a roughly $0.5 billion reduction in fixed costs. Meanwhile, free cash flow was about $0.8 billion with adjusted conversion of only 68%.

"I am pleased with the quarter-over-quarter improvements in sales growth, margin expansion and adjusted earnings per share that we delivered in the third quarter," Chairman and CEO Darius Adamczyk said in the press release. "We continued to focus on driving sales growth in areas that have not been as impacted by the current downturn, including defense and space, warehouse automation and personal protective equipment, all of which grew by double-digits organically year-over-year. Recurring software sales also grew double-digits organically, continuing our transformation to a premier software-industrial company."


Aerospace revenues of $2.662 billion (-25% organic sales, small sequential improvement from -27% in Q2) were better than the $2.548 billion expected. Within the segment, on an organic basis, sales declined 47% in Commercial Aviation Original Equipment and 47% in Commercial Aviation Aftermarket, but Defense & Space was a bright spot with organic sales increasing 13%. Headwinds to the results were ongoing reduction in-flight hours and slowdown in original equipment build rates, both of which do not come as a surprise due to Covid-19's disruption to the commercial aviation industry.

Meanwhile, segment margins declined by 240 bps to 23.2%, but that's an improvement from the Q2 drop of 510 basis points. Segment operating income was $617 million, up nicely from the $547 million consensus.

Honeywell Building Technologies

Honeywell Building Technologies (HBT) revenue was $1.305 billion (-8% organic, strong improvement from -17% in Q2) and that exceeded expectations of $1.237 billion. Driving the decline was primarily lower demand for building management systems, security and electrical products and softness in Building Solutions due to delays in projects and energy businesses. However, management was encouraged with the sequential improvement to organic growth and cited positive momentum into the fourth quarter.

When people return to the workplace, they are going to want to work in "Healthy Building" and Honeywell's offerings help provide just that. Meanwhile, segment margins expanded by 60 bps to 21.6%, and that's an improvement from the Q2 increase of 50 basis points. Segment operating income was $282 million a beat against the $267 million consensus.

Performance Materials & Technologies

Performance Materials & Technologies (PMT) sales of $2.252 billion (-16% organic, small sequential improvement from -17% in Q2) was a miss versus expectations of $2.33. billion. Within the segment, organic sales were down across the board, declining 36% at UOP, 12% at Honeywell Process Solutions, and 4% at Advanced Materials. It was a similar story on the margins front as segment margin contracted by 220 bps to 10.6%, but that's an improvement from the Q2 decline of 460 basis points.

Segment operating income was $442 million a small miss against the $460 million consensus. This segment will lag the broader economic recovery due to its exposure to oil, but there was also some pockets of strength here in packaging and composites as well as auto refrigerants, which are tied to the recovery in auto end markets.

Safety & Productivity Solutions

Looking to Safety & Productivity Solutions (SPS), sales of $1.578 (+8% organic, strengthening from +1% in Q2) billion roughly matched estimates of $1.578 billion. SPS posted positive organic sales growth of 6% and 9%, respectively. Driving the quarter was double-digit growth at Intelligrated, which saw its backlog increase by over 100%. Meanwhile, demand for personal protective equipment was strong and posted double-digit growth in the quarter led by respiratory products. Segment margins expanded as well to 13.9%, and that's up 50 basis points YoY and 150 basis points from Q2. This is a positive outcome because Honeywell experienced some margins headwinds as new capacity for PPE was implemented. In total, segment operating income was $219 million, a small miss relative to the $225 million consensus.

Capital Allocation

On the capital allocation front, we remind you that the company recently announced a dividend increase, representing the 11th consecutive year of dividend increases. Meanwhile, the company had $249 million in capital expenditures, which went to investments dedicated to producing much needed N95 masks and to increase capacity in our warehouse automation business. Honeywell has about $15 billion of cash and short-term investments on hand and has one of the best leverage ratios in the sector.


For the fourth quarter, management expects total sales between $8.2 billion and $8.5 billion with organic growth down between 14% and 11%. Consensus for the fourth quarter is at $8.4 billion, so this forecast is slightly below to largely in line.

Segment margins are expected to be between 21.1% to 21.3%, representing a year-over-year contraction of 30 to 10 basis points, solid sequential improvement, and a better-than-forecast relative to the consensus of 20.7%. Management estimates fourth quarter adjusted earnings per share will be in the range of $1.97 to $2.02, and this is well ahead of the consensus of $1.88.

All in all, while the sales forecast is a bit light, management's execution on costs and decremental margins should translate to a much stronger-than-expected bottom-line figure.

On a more granular level, the company expects sequential sales improvement across all four segments. The factors driving this outlook include continued momentum of Honeywell's portfolio of healthy solutions, double-digit year-over-year growth in defense, warehouse automation, and PPE (bright spots in Q3), and an ongoing recovery in commercial aftermarket,

Thinking ahead to 2021, the slide below details management's preliminary thoughts for 2021:

Elsewhere, management plans to capitalize on its strong balance sheet capacity and use it for M&A as well as share repurchases. Management plans to reduce share count by at least 1% in 2021 and they will resume buybacks as early as Q4. Deployment of capital through these two channels represents a potential upside driver to estimates. Speaking to M&A, Adamczyk called his current pipeline of targets "very robust."

Overall, this was a better-than-expected quarter here with strong operational performance amid challenging times. Although it wasn't a beat across every line item, Honeywell reported solid-to-strong sequential improvement across the board and showed execution on costs to protect its margins. The shares are currently roughly flat on the day but well off their lows of the session in what has been a very difficult tape.

So long as the economic recovery continues and a vaccine in early 2021 begins to restore consumer confidence in air travel, Honeywell's expected return to growth and margin expansion in 2021 along with robust capital deployment through share repurchases and M&A should lift next year's earnings per share significantly above 2020 levels. For these reasons, we reiterate our One rating and continue to believe the stock is one of the more attractive recovery plays in the industrial group.