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Morningstar | Honeywell Once Again Posts Exceptional Performance; We're Raising Our FVE. See Updated Analyst Note from 23 Jul 2018

Wide-moat Honeywell posted exceptional second-quarter 2018 results, and we are raising our fair value estimate to $156 from $150. On the heels of strong growth, Honeywell's management is raising its full-year 2018 guidance to a new range of 5%-6% for top-line organic growth (from 3%-5% previously), segment margin expansion of 40-60 basis points (from 30-60 basis points previously), and EPS guidance to a new range of $8.05-$8.15 (from $7.85-$8.05 previously). Historically, Honeywell has been notorious for providing conservative guidance, preferring to set realistic goals and leaping over any hurdles it sets, to the delight of investors. The market has caught on to Honeywell setting low expectations, as analyst forecasts for the stock often run ahead of guidance, and for the majority of this year, this has been no exception.

Revenue rose to $10.9 billion for the quarter, an 8% year-over-year increase (6% organic) from last year's second quarter. Top-line growth was largely broad-based, and 70% of Honeywell's portfolio grew about 5% or more organically. Undoubtedly, this is an impressive figure among peers, which often grow about a point above GDP at best, and it lends credibility to Honeywell's tilt toward becoming more of a software industrial company. Another strategy clearly working in Honeywell's favor is its emphasis on high-growth regions such as India, which elicited double-digit organic sales growth in the quarter within building solutions. Segment margins rose 60 basis points year over year, to 19.6%. Sales volumes were the primary driver for the margin uptick, along with other organic growth initiatives, which exceeded management's guidance. These margins, however, exclude spin-related separation costs of $346 million for the quarter.

Turning to Honeywell's segments, aerospace posted outstanding results, up 10% year over year to $4 billion (8% organic). Segment margins also rose 30 basis points year over year to 22.6%. Aerospace benefits from strong tailwinds in both original equipment and in the aftermarket. Specifically, the original equipment market benefited from growth in defense spending--both in the United States and abroad--and from business aviation. Defense and space specifically grew 15% year over year. The commercial aftermarket is also seeing strong growth, which we believe demonstrates the strength of Honeywell's decoupled offerings that disrupt the traditional installed base model and are less dependent on traditional drivers like flight hours. Safety and productivity solutions was another key contributor to top-line and margin growth, beating our expectations for the year on a run-rate basis. Warehouse automation is clearly a long-term opportunity for the firm, as few warehouses in the United States are automated at this stage (estimates are about 5%, as of last year).

We expect Honeywell to continue its strong results, particularly given CEO Darius Adamczyk's bullish comments at the electrical products group conference earlier this year and reiterated on the call today. While backlog isn't always the best indicator of future sales growth (customers can cancel contracts), long-cycle backlog was notably up 14%, with strength in Intelligrated (in safety and productivity solutions), defense (aerospace), Universal Oil Products (in performance materials and technologies), and Honeywell productivity solutions (in safety and productivity solutions).