EUR 850.00 For Business Accounts Only

Morningstar | Honeywell Is a High-Quality Industrial With a Long Runway for Growth

After transitioning coverage to a new analyst, we are lifting our fair value estimate to $168 per share from $156 previously after this most recent quarter raise (from $150 when our prior analyst covered the name), as well as raising our stewardship rating to Exemplary, respectively. We are, however, retaining our wide-moat, stable trend, and medium uncertainty ratings.

Our more optimistic thesis is based on three long-term factors--Honeywell’s unique culture, rigorous operating process, and its high-growth, moaty portfolio--the latter which we believe will drive higher organic revenue growth, and ultimately translate to greater shareholder returns. We think the firm has successfully transformed itself into a software-industrial player, and we see this transition only increasing over time. While players like narrow-moat rated GE have stumbled along the way by overextending itself in the quest for digitization, we think Honeywell has positioned itself for success by focusing on the end markets it knows best.

We’re especially bullish on warehouse automation, for example, and believe positive macroeconomic trends like a rise in e-commerce package volumes should propel its productivity solutions business toward a 9% compound annual growth rate over the next five years. Honeywell undoubtedly strengthened its position in the space with the acquisition of Intelligrated in 2016. Intelligrated brought with it a portfolio of robotics and control software assets that Honeywell was previously lacking. Intelligrated, however, benefits from Honeywell’s scale, its access to additional markets, as well as its long track record of success, which is particularly important to its e-commerce end market.

We ultimately believe that software solutions will benefit Honeywell by reinforcing customer switching costs and allowing Honeywell to generate high returns on incremental invested capital through lower capital investment, margin accretion, and increased revenue growth. For example, by 2019, Honeywell aerospace segment plans to connect about 80% of its 100-plus aerospace products, allowing Honeywell to be the platform around an ecosystem of products. A common theme we see across its segments is Honeywell’s investment into an expansion of its installed base that initially depresses returns given the required outlay, but later allows Honeywell to enjoy years of higher-margin, more stable service revenue (that is the familiar razor and blade model). Accordingly, we model about a 4-point rise in ROICs by the end of our midcycle (beginning from 2018 estimates) as Honeywell leverages this installed base and increasingly benefits from opex-related customer spending. Opex spend currently represents about 60% of its portfolio offerings and includes offerings like software upgrades.

Insights into Honeywell’s unique culture and process can be gleaned from its selection of current CEO Darius Adamczyk, where key attributes for the role were defined about a decade ago and former chairman David Cote primarily relied on successful CEOs from other industrials (rather than paid third-party consultants). Adamczyk has built a long track record of success and we were impressed when he spoke at this year’s Electrical Products Group Conference and declared “war on fixed costs.” If anyone can help Honeywell attain and maintain the premium multiple we think Honeywell deserves, we think Adamczyk is the person to do it.

Adamczyk is incredibly rational, and we were impressed how he handled challenges from Dan Loeb’s Third Point early in his tenure. With the proposed spin-offs of Transportation Systems and Loeb’s Homes businesses, he didn’t entirely acquiesce to Third Point’s demands, displaying independent thought, but also demonstrating a willingness to part with the past in markets where Honeywell faces an eroding competitive position.