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Honeywell decline on light sales and conservative guidance is a buy
Shares of Honeywell on Thursday afternoon were paring earlier losses after the industrial conglomerate reported mixed fourth-quarter results and weak forward guidance. While earnings, profit margins, and cash flow came in slightly ahead of expectations, sales were light across the board. Revenue rose 2.8% year over year on a reported basis to $9.44 billion versus expectations of $9.7 billion, according to estimates compiled by data provider LSEG. Organically, sales grew 2%. Adjusted earnings per share of $2.60 advanced 3.2%, a penny above the $2.59 consensus forecast. Segment margin , similar to an adjusted operating income margin, grew 64 basis points to 23.5%, slightly ahead of expectations and ahead of the high-end of management’s previous forecast. HON 1Y mountain Honeywell 1 year Honeywell came off morning lows as the overall stock market extended its rally in last afternoon trading. Shares are still down about 3% on the session and 6.5% year to date. Bottom line The quarter wasn’t great. Sales were disappointing as even the star of the show, Aerospace, came up short. What keeps us interested in the stock and prompted us to purchase more shares Thursday morning is the view that things are set to improve from here. Segment margin performance was largely better than expected, with the exception of Building Technologies, and cash flow generation came in solidly above expectations. Neither of these areas of strength was enough to offset the quarterly sales or overall segment profit misses. However, the margin and cash flow performances do speak to management effectively executing on the variables in their control by making the company leaner and positioning the company to win as the macroeconomic backdrop improves. Looking ahead, management expects their short-cycle business – sales that don’t take as much time to complete – to rebound in the second half of the year. On the post-earnings call, the team said, “Outlook is somewhat tempered by the uncertain timing of an eventual recovery in the short-cycle as markets return to normalcy which we see as the swing factor to our sales outcome for the year.” They also said the timing of the short-cycle rebound in the U.S. will be influenced by interest rate dynamics. That’s crucial because, as management pointed out, Honeywell’s short-cycle portfolio contains “some of the highest margin businesses.” Where they landed on guidance both in terms of sales and margin performance, and therefore earnings, hinges on the short-cycle recovery. We think they’re playing it close to the vest and providing a cautious guide to start the year. The guidance also does not include the acquisition of Global Access Solutions, the security unit of Carrier Global. The transaction is expected to be completed in the third quarter of 2024 and immediately be accretive to growth and margins. Even if that short-cycle recovery doesn’t happen sooner than expected and plays out in line with management’s timeframe, we want to be in before this happens. That’s why we used weakness in the stock like we saw Thursday to increase our exposure. By the time we get to the second half of the year, the market will already be looking to 2025. If a short-cycle recovery materializes by then, shares will already have moved higher. With guidance now out in the open, the risk-reward at current levels of just under $200 per share is favorable, which is why we stepped up to the plate shortly after the print. We are reiterating our buy-equivalent 1 rating and reaffirming our $230-per-share price target. Quarterly commentary As we can see in the earnings table above, this wasn’t a great quarter in terms of sales for any segment. However, Aerospace remains the key driver of growth, up 14.6% versus the year-ago period to $3.67 billion, with commercial aerospace notching an 11th consecutive quarter of growth. An increasing focus on national security also drove 5% organic growth in the defense and space business despite supply chain challenges. Aerospace along with Performance Materials and Technology (PMT) were also the key drivers behind the overall 64 basis points of Q4 margin expansion. PMT sales of $3.03 billion benefited from strength in process solutions, which saw double-digit growth in aftermarket services. The segment also benefited from 4% organic growth in process solutions and a 1% increase in UOP, Honeywell’s petrochemicals business. The 23.7% drop in Safety and Productivity Solutions sales to $1.23 billion was driven by softness in warehouse and workflow solutions and productivity solutions and services, which were down 51% and 24%, respectively, on an organic basis. On the call, management noted that Productivity Solutions and Services is suffering from continued distributor destocking dynamics, but added that “over 30% orders growth in the quarter provides some confidence that we are near the end of that cycle.” Honeywell Building Technologies (HBT) was down slightly to $1.5 billion as strength in building solutions, which is characterized as long-cycle, was more than offset by weakness in short-cycle building products Guidance Looking at the guidance table above, management’s outlook for the current quarter (fiscal 2024 first quarter) and full year came in mostly below Street expectations. As noted above, the guidance is accounting for the uncertain timing around the short-cycle recovery. We suspect that the team has added an increased element of caution to the guide as a result. Full-year segment margin guidance of 23.15% at the midpoint was higher than estimates. Our confidence in Honeywell’s ability to over-deliver on this guide also stems from the record backlog at the end of the Q4. It advanced 8% year over year to a record $31.8 billion. The strong backlog, gives us confidence in the path ahead, was driven by growth in Aerospace, PMT and HBT. Additionally, when the acquisition of Carrier’s security business is completed later this year, it should further strengthen the company’s overall balance sheet and ability to generate cash. That cash could be used to strike other deals or come back to shareholders in buybacks and/or dividends. Tie it all together and we think this guidance has a good chance of being raised in coming quarters, as long as the economy remains resilient. New segment structure As a reminder, at of the start of 2024, the previously announced operating segment overhaul takes effect. Honeywell will be reorganized into four units: Aerospace Technologies, Industrial Automation, Building Automation, and Energy and Sustainability Solutions. That means a slightly different format when the company reports first-quarter 2024 earnings. Management’s commentary on individual segment outlook during the Q4 call was based on this new breakdown. Robust demand in Aerospace Technologies is expected to remain throughout the year, with the team adding that commercial original equipment build rates continue to grow, that commercial aftermarket sales should see a continued to benefit from an improvement in flight hours as international travel continues to normalize, and that the limiting factor in defense and space will be supply constraints, not demand. Industrial Automation results will be heavily reliant on the timing of the short-cycle recovery but are overall guided to be “flattish in 2024”. In Building Automation, the long-cycle businesses are again expected to outpace the short-cycle ones, though we should see some catch-up from the short-cycle side in the second half of the year as inventory levels normalize. Overall, sales in this segment are projected to grow low-single digits on a percentage basis for the full year, with the most margin expansion. In Energy and Sustainability Solutions, management said, “The macro environment will provide both puts and takes in 2024,” concluding that net/net it should amount to flat to up low-single-digit sales growth for the full year versus 2023. That, which along with an expectation for further margin expansion, implies segment profit growth in 2024. The first quarter, however, is expected to be down before we start to see improvement as the year progresses. (Jim Cramer’s Charitable Trust is long HON. See here for a full list of the stocks.) 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Shares of Honeywell on Thursday afternoon were paring earlier losses after the industrial conglomerate reported mixed fourth-quarter results and weak forward guidance. While earnings, profit margins, and cash flow came in slightly ahead of expectations, sales were light across the board.
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