• Aerospace, process automation, and building products continue to combine for above-average growth at Honeywell, offsetting weakness in safety and productivity.
• Ongoing productivity initiatives and strong trends in aerospace should offset most of the risks of wobblier end-market conditions in non-residential construction and process automation.
• Honeywell's better positioning in this part of the cycle could make it a safe haven for institutions, but valuation is already quite robust.

In a quarter where it has becoming increasingly clear that short-cycle industrial markets are slumping and long-cycle markets are starting to wobble, Honeywell’s (HON) steady performance and minor beat-and-raise for the second quarter certainly solidifies the safe haven credentials that have been part of my bullish thesis on the stock. With a strong Aerospace segment and steady performance in Building Tech and PMT offsetting temporary weakness in Safety and Productivity, there’s not much that concerns me about the performance for the company.

What does concern me is the valuation. Although Honeywell has modestly outperformed industrials since my last update, almost all of that outperformance came in the post-earnings jump. Moreover, I’m concerned that we’re going to see a downward revision cycle after this earnings reporting cycle across industrials and a reset in valuations as investors accept that the second-half rebound thesis is looking pretty shaky. I do believe that Honeywell’s valuation could continue to exceed historical norms as institutions flock to own one of the few industrial stocks that’s “working”, but I don’t like playing the game of assuming that above-trend valuation will continue to expand at a time when the sector is seeing downward re-ratings.

Not Perfect, But A Good Quarter On Balance

I have liked Honeywell for its relatively low exposure to problematic short-cycle industrial markets and its significant exposure to longer-cycle markets with good growth characteristics like aerospace. That all came together to deliver a pretty good second quarter, with segment level profits beating expectations by a penny.

Overall revenue rose 5% on an organic basis, led by Aerospace at 11%. Within Aerospace, Defense and Space was particularly strong, with an impressive 20% organic growth rate, though the 8% growth in Commercial Aftermarket is quite good too. Building Tech and PMT both did fine, with 5% and 4% organic growth respectively, as Honeywell saw 5% growth in the refinery-driven UOP business and 5% growth in its process automation business, while the more diversified Advanced Materials grew 2%.

Safety and Productivity was the outlier and the problem child with a 4% organic revenue contraction in the quarter. Safety was up a little (up 1%), helped some by the gas detection business, but Productivity was down 7%. The Productivity Products business was down a surprising 26% (not encouraging for Zebra (ZBRA) ), Sensing/IoT was flat, and Warehouse/Workflow slowed from 50%+ growth in Q1 to just 7% growth as warehouse automation project activity slowed against tough comps.

Adjusted segment profit rose more than 8% in the quarter (slightly better than expected), with 80bp of margin improvement. Building Tech, up a reported 8%, was the best performer relative to expectations (and reported segment margin improved by almost four points), but Aero and PMT both outperformed expectations as well, offsetting a significant shortfall in the SPS business.