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Morningstar | As It Almost Always Does, Honeywell Turns In Another Solid Operating Performance

Wide-moat Honeywell had a solid fourth quarter, and its full-year 2018 results were broadly in line with our expectations. As we roll our model forward for 2019, we may modestly increase our $150 fair value estimate for both the time value of money and recalibration of our homes and building technologies assumptions on higher commercial segment profit margins after the spin-off of Resideo (to about 20.5% after the spin-off, according to management disclosures versus about 17.3% from full-year 2018 levels). We also reiterate our wide moat, stable trend, medium uncertainty, and Exemplary stewardship ratings.

Full-year sales for the overall firm totaled $41.8 billion against our expectations of $41.9 billion. Total segment profits for the firm equaled $8.2 billion and income before taxes were $7.5 billion, nearly exactly in line with our expectations, while adjusted EPS came in at $8.01 per share against our expectations of $7.97 (we were slightly too aggressive in our tax assumptions for the firm). Results were propelled by both safety and productivity solutions (we really like the warehouse automation business) and aerospace.

CEO Darius Adamczyk gave some interesting color on the call regarding the macroeconomic environment. He expressed some conservatism, which we thought was an interesting contrast to his remarks nearly a year ago at the EPG multi-industrial conference. We think the conservatism is warranted, given that about 60% of Honeywell’s businesses are short-cycle. Nevertheless, we reiterate our thesis that Honeywell is an ideal confluence of culture, process, and portfolio rolled up into one conglomerate. We expect its rigorous operating process will continue driving value and margin expansion for years to come, while portfolio businesses like warehouse automation will continue driving rapid sales growth at low double digits.

Of course, the aerospace industry has shown some real strength across multiple companies in our coverage, driven by revenue passenger miles. Like many of its counterparts, Honeywell saw increased demand on the defense side as well as the commercial aftermarket. Aerospace also happens to be Honeywell’s widest-moat company, in our view. Unlike its counterparts, though, Honeywell has the additional advantage that its connectivity offerings are appreciably less exposed to a cyclical downturn in global passenger air travel. Further positives for this long-cycle business include its backlog, which is up double digits year over year.

For safety and productivity solutions, Intelligrated continued to see double-digit sales growth, both for the full year and for the quarter. In the fourth quarter, the segment impressively saw an outstanding 15% year-over-year top-line growth rate. While most of this business from our understanding is short-cycle, warehouse automation is longer-cycle, and Intelligrated’s backlog is now up 30% year over year for the fourth quarter. While the performance materials and technologies segment was flat year over year amid declining oil prices, the firm was able to offset these pressures and still managed to impressively expand operating margins by 200 basis points with some portfolio repositioning away from the oil and gas cycle, as well as operational improvement efforts and additional catalyst shipments.

The stock of Honeywell inexplicably dipped to below $125 on Christmas Eve, providing a rare opportunity to buy into one of the highest-quality multi-industrials at a fair (but not pound-the-table) price. Since then shares have increased between 15% to 20% as they rapidly converge on our $150 fair value estimate. While we expect the company to continue its exceptional performance, and there’s little not to like about Adamczyk’s team’s stewardship of the firm, we no longer believe there is a sufficient margin of safety to warrant additional investment in the stock (even when accounting for Honeywell’s reputation for conservatism in its guidance). Even so, we recommend putting this stock on a watchlist if shares trade down based on an overreaction to fears of a global economic recession.