EUR 850.00 For Business Accounts Only

Morningstar | Productivity Product Slowdown Doesn’t Change Our Positive Honeywell Thesis

Nothing in Honeywell’s latest results alters our optimistic long-term view of the firm. As a result, we leave our fundamental assumptions unchanged. We plan to slightly raise our fair value estimate to $164 per share, due entirely to the time value of money. Second-quarter 2019 results were strong, with the company posting robust sales. The company grew its top line organically 5% year over year to $9.2 billion. We consider organic growth a more meaningful signal of performance after the spin-off of Resideo and Garrett Technologies last year.

Overall segment operating margins grew 170 basis points to 21.3%, which we consider impressive given the business disruption normally associated with spin-offs. Management did slightly raise the lower end of its top-line and EPS estimates, but both our sales projections and net income assumptions were in line with it guidance. Indeed, our top-line estimate is at the top end of the guidance range, which management left unchanged. However, we’re modeling additional share buybacks. Given where the stock is trading relative to our rolling fair value estimate, we consider these repurchases mostly value-neutral.

Sell-side analysts exhausted the brunt of their questions on issues currently affecting one of Honeywell’s short-cycle businesses in safety and productivity solutions, which traditionally is Honeywell’s fastest-growing segment. The slower-growing portion of SPS that did take a hit during the second quarter was Honeywell’s productivity solutions. The company highlighted the potential issues posed with distributor inventory destocking earlier in the year, and we believe these headwinds are flowing through to results. While we don’t believe these issues will reverse heading into the third quarter, we ultimately believe these gripes are shortsighted.

Warehouse automation forms a larger part of SPS’ mix and constitutes an important part of our Honeywell thesis (about 65% of the productivity solutions subsegment). It is true that SPS comps are becoming increasingly difficult. It’s hard and mathematically improbable to meaningfully outperform nearly 20% year-over-year growth for any extended period. Short-cycle businesses are also inherently harder to predict, while long-cycle businesses benefit from backlog visibility. We surmise warehouse automation orders are simply being pushed out. CEO Darius Adamczyk confirmed this in the earnings call. In fact, Adamczyk stressed these orders are “still out there” and the company expects to book them in either the third or fourth quarter of 2019.

Even with these delays, warehouse automation grew its business nearly 7% year over year. Over the next five years, we believe this business can grow at a high-single-digit to lower-double-digit compound annual rate. While some mistakenly believe this segment is overly exposed to Amazon, we point out that Intelligrated has over 30 major retailers ranging from Molson-Coors to Adidas to Hershey to McKesson, among others. We attended the Automate 2019 Conference in Chicago and spoke with Intelligrated competitors that see many of the same growth drivers we do, including labor and worker safety regulation, higher wage growth, as well as customer need to drive greater efficiencies.

We believe Honeywell has done a good job of building its warehouse automation offering with selective bolt-on acquisitions. We’ve also been impressed with Honeywell’s technology, which includes fully autonomous mobile robotic unloading solutions. Finally, we’re encouraged that Adamczyk has said in recent interviews that warehouse automation is in the early stages in Europe. Overall, we think the recent strong results in aerospace (which grew its organic top line at a convincing 11% year over year) and robust results in process solutions (which grew its organic top line 5% year over year) confirms our thesis that Honeywell remains one of the best-positioned multi-industrials for long-term growth.