Summary
- Honeywell's third quarter revenue was a little soft, with Aerospace having to do most of the heavy lifting on strong demand in Defense and Space.
- Margins were better than expected, with all but PMT coming in above Street expectations.
- Honeywell remains well-positioned with respect to end-market exposures and there are further opportunities for margin improvement, but the shares aren't cheap.
I have to admit that Honeywell's (HON) lackluster share price performance over the past three months has surprised me, as I expected this well-loved multi-industrial to benefit from some "safe haven" investment flows as the data on a broader industrial slowdown continued to accumulate. Whether I underestimated how much of that had already taken place, or whether investors were a little put off by valuation, I don't know, but Honeywell has lagged its industrial peers a bit since the second quarter earnings update, though the company is still among the outperformers of the past year.
There wasn't really anything in Honeywell's third quarter that changes my view. The company's longer-cycle process businesses are holding up and aerospace should remain strong for some time. Weakness in productivity/automation should be transitory, and the company continues to do well on margins. Healthy mid-single-digit long-term FCF growth and strong margins/ROIC/ROA support a robust valuation for Honeywell shares, but I can't call these shares undervalued today.
A Decent Result In A Tougher Market
Honeywell did nothing special in terms of its revenue performance, with a slight miss relative to expectations, but margins came in better than expected, helping drive a roughly $0.03/share beat at the segment income line. Still, that's less than half of the overall reported per-share beat, so while Honeywell's third quarter was better than expected, it wasn't a particularly impressive beat for a company where expectations are already pretty high.
Revenue rose 3% in organic terms, driven by another impressive performance in the Aerospace business. Gross margin improved almost four points, helped in part by the margin-lifting disposals Honeywell executed last year. Adjusted operating income rose 4%, while adjusted segment income rose almost 8%, with 80bp of margin improvement.
Aerospace revenue rose 10%, with Defense & Space leading at 17% growth, but both sides of Commercial did well (original equipment up 7%, aftermarket up 6%). Segment margin improved by more than three points, helped by the Garrett (GTX) transaction, and the Street remains somewhat concerned about margin prospects in 2020. These results should be encouraging for Eaton (NYSE:ETN), General Electric (GE), Parker-Hannifin (PH), and United Technologies (UTX), and there seems to be little concern that aerospace demand will abate meaningfully in 2020.
Building Tech produced 3% growth, with respectable trends in fire and building management. Also helped by spin-off activity (Resideo (REZI) ), margin improved about four points. While Fastenal (FAST) noted healthier trends in non-residential demand, much of this has been supported by larger projects. With that, I'm not quite sure how to assess this for companies like Johnson Control (JCI) or United Technologies - non-residential construction demand seems to be hanging in there, but it also does seem to be fading, and I'm worried that the pipeline of larger projects isn't refilling.
Safety and Productivity was the more troubling part of the business. Revenue declined 8%, with flat performance in Safety (a mixed read-through for recently-underperforming 3M (MMM) ) and a double-digit decline in Productivity, including a 20% pullback at Intelligrated on destocking and project pushouts. Margin declined more than three points. Other vendors serving similar automation/productivity markets, including Cognex (CGNX), Daifuku (OTC:DFKCY), and KION (OTCPK:KIGRY) had already warned about these trends.
Finally, Performance Materials and Technology posted an okay quarter, with 3% organic growth on 7% growth in Process Solutions, flat performance in UOP, and a 2% decline at Advanced Materials. Margins improved slightly (less than a point). Between the healthy results from Honeywell's Process Solutions (including strong order growth) and the strong results from Dover's (DOV) Fluids business, this should be relatively encouraging for Emerson (EMR) and perhaps SPX Flow (FLOW) as well.
