Honeywell (HON, Financial), a diversified technology and manufacturing company, has been an excellent shareholder value creator company. In the last two years, the stock has given returns of 68% and is currently trading at a price of $93.3 and a dividend yield of 1.9%. This article discusses the factors for remaining bullish on Honeywell for the long-term.
Strategic Sales Shift
Honeywell has gradually changed its sales profile over the last decade with more investments in the high growth countries. In 2003, the company has only 10% of its revenue coming from high growth countries (CAGR 15%). In 2013, the revenue contribution from these high growth countries has increased to 23% of the total revenue.
As sales in these countries grow in excess of 15% on an annual basis, the company is well positioned to continue reducing its dependence on developed markets. In particular, China has been one of the key growth drivers in the past decade.
However, the slowdown in China is not a major concern as other emerging markets like India and Brazil are gradually becoming important markets for Honeywell. Also, China’s long-term growth story is still intact and renewed growth can spur further sales boost for Honeywell.
Big Cash Flow Expected
With robust growth in emerging markets and low, but steady growth in developed markets, Honeywell expects to generate cash flow from operations in the range of $30-$33 billion over the next five years. Even the lower end of the guidance is nearly 41% of the company’s market capitalization.
Of the total cash inflow, Honeywell intends to distribute 50% of the funds to shareholders through dividends and share repurchase. Therefore significant shareholder returns are lined-up for the next five years and this should help the stock trend higher as it has in the last two years.
The remaining 50% of the cash inflow is expected to be invested in mergers & acquisitions along with capital expenditure for organic growth. Overall, the company intends to generate sales in the range of $5-$8 billion over the next five years from inorganic growth. Investors can therefore expect some big acquisitions over the next few years with the company already having a strong pipeline of potential targets.
Considering the company’s focus on emerging markets, I do believe that a bulk of these acquisitions will come in emerging markets or will be companies with higher sales in emerging markets. From an investor’s perspective, the key point is that Honeywell will continue to increase its sales and EPS along with significant shareholder returns. The company is targeting double digit EPS growth over the next five years and if this is achieved, the stock will have a long-term upside trend.
Strong Results And Guidance For FY14
Another positive for 2014 is the company’s strong results in 1Q14 and an equally strong outlook for 2014. For 1Q14, the company reported an EPS growth of 10% (using normalized tax rate) and this growth is in line with the company’s target for the next five years.
More importantly, the company revised the guidance for 2014 from $5.35-$5.55 per share earnings to $5.40-$5.55 per share. At the higher end of the guidance the full year EPS growth will be at 12% and should the company achieve this, the stock will have another upside trigger.
Besides increasing the lower end of the guidance, the company has also increased the cash flow forecast for 2014 after a strong 1Q14. For the first quarter of 2014, the company’s operating cash flow and free cash flow increased by 102% and 157% respectively as compared to 1Q13. For the full year, the new free cash flow guidance is in the range of $3.8-$4.0 billion.
Honeywell will therefore have significant cash for dividends, share repurchase and any potential acquisition. It is also important to mention here that Honeywell has a strong cash position of $6.7 billion along with accounts receivable of $8.1 billion as of March 2014. This adds to the company’s strong financial flexibility.
Conclusion
Honeywell has always been a value creator and the company’s stock price upside in the last two years has been phenomenal. Given the company’s financial position and growth plans, Honeywell will continue to create value for shareholders in the long-term.
At a current stock price of $93.3, the stock is trading at a TTM PE of 18.7 and the valuations are relatively attractive with BorgWarner (BWA, Financial) currently trading at a PE of 23.5 and Johnson Controls (JCI, Financial) trading at a PE of 24.7. Investors can therefore consider exposure to the stock at current levels with a medium to long-term investment horizon.
