The industrial sector is lower by more than 17% year-to-date, and yet Honeywell International (HON, Financial) has climbed just over 1%. While a small improvement in the share price isn’t a cause for celebration in a vacuum, Honeywell International’s vast outperformance of its industry in 2022 shows that the company has gained significant popularity among investors.
There have been several reasons why the stock has done so well this year, including that the company is seeing high levels of organic growth. Along with that, margins are improving, which is a tough feat giving the current operating environment. In this article, we will explore why the market is bullish on Honeywell.
Recent earnings results
Honeywell reported third-quarter earnings results on Oct. 27. The results were mixex. Revenue did improve nearly 6% to $8.95 billion, but came up $44 million less than expected. Adjusted earnings per share of $2.25 compared to $2.02 in the prior year and topped estimates by 10 cents. This was also 5 cents above the high end of company guidance.
Organic growth for the period was 9%, which was at the midpoint of guidance. Leadership had previously predicted segment margin to decline up to 30 basis points or be flat, but instead the company saw margins improve 60 basis points to 21.8%.
Looking closer at each segment, we find that the majority of the business saw improvements during the quarter.
Aerospace grew 10% organically, driven by a 25% improvement in revenue for commercial aviation. Defense volumes were lower. The margin increased 40 basis points to 27.5%
Honeywell Building Technologies was up 19%, with high demand in building products, fire products and building management systems. This segment's margin grew 60 basis points to 24.1%.
Performance Materials and Technologies grew 14%. Advanced materials were higher by 33% due to the strength seen throughout the portfolio. Gas processing and refining catalysts had improvements in demand. The margin expanded 40 basis points to 22.6%
Safety and Productivity Solutions was lower by 4%. Lower demand for warehouse automation and personal protection equipment was only partially offset by double-digit gains in advanced sensing and gas detection. Despite this weakness, the margin surged 250 basis points to 15.7%.
Honeywell provided updated guidance for full-year 2022. Revenue is now forecasted to be in a range of $35.4 billion to $35.7 billion for the year, down frm $35.5 billion to $36.1 billion forecasted previously. Adjusted earnings per share are now expected to be $8.70 to $8.80, compared to $8.55 to $8.80 previously. At the midpoint, this would be an 8.6% increase in adjusted earnings per share from 2021.
Multiple reasons for optimism
Looking through the quarter, there appear to be many reasons that investors could be excited about Honeywell International. Organic growth was strong and would’ve been higher if not for the discontinued business in Russia. Inflationary pressures were evident in most segments during the quarter, but Honeywell International’s ability to raise prices help to offset this headwind. This also shows that the company’s products are still in demand as customers didn't stop buying even at higher prices.
The three largest components within the company also saw double-digit organic growth. The increase in commercial aviation is a welcomed sign for Honeywell as this was the area that was most negatively impacted by the Covid-19 pandemic. With restrictions now lifted in most areas, the demand for air travel, and thus aviation products, has returned. Aerospace revenues for Honeywell are still 16% below pre-pandemic levels. There is still a way to go to reach above pre-pandemic levels, but the improvement on a year-over-year basis is an important sign.
All four segments demonstrated margin expansion as well, including Safety and Productivity Solutions, which was the lone area of the business to decline. Each segment also has improvements in margin compared to the second quarter of 2022.
Guidance for the full year is another positive sign, as management raised the low end of both organic growth and adjusted earnings per share. Revenue was lowered primarily due to currency exchange headwinds and lost Russian sales, which aren't the company's fault.
Moreover, the company should see a sequential pick up in results as well. Fourth-quarter sales are expected to be higher by 10% to 13% with adjusted earnings per share growing 18% to 22% compared to the prior year. Segment margin is forecasted to be 22.8% to 23.2%. Recall that Honeywell's most recent quarter saw the company turn in results that were at the midpoint or above company guidance on organic growth, adjusted earnings per share and segment margin.
Another sign that business is improving is that the company’s backlog continues to grow.
Source: Honeywell Investor Presentation
The last three years has seen fairly steady growth of the company’s backlog. This applies to most of 2020, even though the beginning of the Covid-19 pandemic did impact demand for products and services. The growth of the backlog and the fact that it is now at a record level shows the overall demand and strength of Honeywell's portfolio. Especially inmportant is that Aerospace is a primary reason for the growth in the backlog.
Valuation
That said, Honeywell has a GF Score of just 78 out of 100, implying middling performance is expected going forward based on a historical study from GuruFocus. This score is derived from strong showings for momentum and profitability, middling scores for financial strength and value and a low score for growth.
With the stock trading at close to 24 times forward earnings estimates, Honeywell isn’t cheap. For context, the 10-year average price-earnings ratio is just under 19, according to Value Line.
The GF Value chart is slightly more optimistic, but still shows the stock trading above fair value.
With a price-to-GF-Value ratio of 1.03, Honeywell is rated as fairly valued by GuruFocus.
However, Honeywell has a solid dividend growth track record, having raised its payments to shareholders for 13 consecutive years. Shares have a forward dividend yield of nearly 2%, which is slightly ahead of the 1.7% average yield of the S&P 500 Index.
Final thoughts
Honeywell International has multiple tailwinds working in its favor. Organic growth is occurring at a high rate almost everywhere within the company. Aerospace, the company’s largest segment, is seeing high demand from commercial customers. Segment margin is expanding in all businesses and the backlog sits at a record. The dividend has increased for more than a decade and shares offer a market-beating yield.
This being the case, shares are not offering much of the way in value right now. However, given the multiple positives working in Honeywell's favor, I am still very bullish on the long-term trajectory of the company.
