Investment Thesis
With a strategy to integrate its products into customer operations and generate recurring revenue through aftermarket servicing, Honeywell is a powerful multi-industry company. Over the next five years, the company is anticipated to achieve near-double-digit earnings per share growth, incremental segment operating margins, mid-single-digit organic top-line growth, and free cash flow margins in the mid-teens. Refreshing its portfolio, developing new products, concentrating on high-growth areas, automating the supply chain, increasing efficiency continuously, and moving toward software with a steady income stream are all ways Honeywell can meet these goals. During the COVID-19 pandemic, the company made a smart decision to invest heavily, which could have resulted in share gains for the company. Because of the robust secular trend toward e-commerce, the pandemic hastened the need for automation.Increased productivity is a significant return on investment for customers using Honeywell's automation solutions. Because of its extensive installed base and solvent investments, the company is also well-positioned to take the lead in carbon capture. In order to promote more effective operations, Honeywell is restructuring its portfolio.
Notable Guru Holdings
Mario Gabelli (Trades, Portfolio) (Trades, Portfolio) 93 Honeywell International transactions (GAMCO.png" data-href="" style=""/>
PRIMECAP Management (Trades, Portfolio) (Trades, Portfolio) 38 Honeywell International transactions (PRIMECAP.png" data-href="" style=""/>
Paul Tudor Jones (Trades, Portfolio) (Trades, Portfolio) II 42 Honeywell International transactions (Tudor.png" data-href="" style=""/>
Ken Fisher (Trades, Portfolio) (Trades, Portfolio) 48 Honeywell International transactions (Fisher Asset.png" data-href="" style=""/>
Even though Honeywell does not take up a significant portion of some of the notable Gurus' portfolio, Gurus like Ken Griffin, Ken Fisher (Trades, Portfolio) and Paul Tudor have taken some serious long positions in the stock lately. Ken Griffin's Citadel now has a stake worth $263 million in Honeywell. This is at large an event-driven opportunity pursued by these long/short hedge funds. It also implies that the market perceives a spin off of Honeywell's aviation and automation business and unlocking untapped shareholder value in tandem. Now that activist investor Paul Singer (Trades, Portfolio) is also ramping up pressures at the management, a event driven opportunity in the form of a spin-off is quite likely.
Investment Upsides
With a broad economic moat based on the longevity of its intangible assets and switching costs, Honeywell is a top-tier business in the diverse industrial sector. With goodwill included, Honeywell generates a return on invested capital of 18–20% over a normalized cycle, which is about 10 percentage points higher than the weighted average cost of capital of 8.4%. In the industries in which it works, Honeywell's technical expertise, brand, and long-standing clientele are valuable assets that give it pricing power and expand its moat.With nearly 140 years of operation, Honeywell has a rich history and has developed the quality that is the foundation of its name. For more than a century, the company has been a dependable leader in developing both military and civilian aviation, and its aerospace technologies division supplied essential parts for US military aircraft during World War II. Consumers respect Honeywell's established reputation, and when systems that use Honeywell's products malfunction, it can lead to tragedies like fatalities. Therefore, Honeywell's brand, technical expertise, and long-standing customer relationships are valuable in the industries it works in, giving it pricing power and serving as intangible assets that expand its moat.A significant amount of Honeywell's products are both integrated into the customer's product designs or operations and represent a minor portion of the customer's overall spending budget. Due to expensive operational downtime, redesign, regulatory approvals, and the possibility of system failure, customers typically incur higher costs when switching suppliers of such mission-critical components than the actual savings from doing so. An APU is a low-single-digit percentage of a plane's cost. High-margin recurring revenue is generated by Honeywell's installed base of equipment, particularly in the aerospace and process automation industries, which require Honeywell-branded replacement parts.
In addition to being a small percentage of the customer's total spending budget, a sizable number of Honeywell's products are integrated into the customer's product designs or operations. Customers usually pay more to switch suppliers of such mission-critical components than they save because of costly operational downtime, redesign, regulatory approvals, and the potential for system failure. A low-single-digit percentage of a plane's cost is called an APU. Honeywell's installed base of equipment generates high-margin recurring revenue, especially in the aerospace and process automation industries that need replacement parts bearing the Honeywell brand. With a nearly universal presence in aircraft—found in about 90% of all jets, planes, and helicopters—Honeywell dominates the market for aircraft auxiliary power units in the aerospace technologies (AT) business segment. Due to Honeywell's parts being frequently specified into aircraft designs for many years and the mature industry's slower technological advancements, reinvestment risk in the aerospace sector is still comparatively low. To attract clients and grow its installed base, the company depends on its intangible assets, which include its lengthy track record of success, broad customer relationships, technical expertise, regulatory clearance, and patents. Research and development, which accounts for 4.5% to 5% of the segment's sales and is greater than that of the majority of other diversified industries under our coverage, is the source of Honeywell's technological advantages.In Honeywell's AT segment, switching costs are closely linked to higher-margin aftermarket sales. Because aerospace OEMs typically do not switch suppliers once a design is certified for equipment that performs tasks with a high cost of failure, like in-flight health monitoring and landing assistance, conventional aftermarket, which are tied to traditional flight-hour service contracts for maintenance, repair, and overhaul (MRO), and decoupled offerings, which relate to discretionary aircraft upgrades unrelated to wear and tear, benefit from switching costs.
Because manufacturing process equipment is capital-intensive, Honeywell's Industrial Automation (IA) segment produces lower margins and returns on capital than its other segments. In relatively new markets with dynamic disruptions and less certain competitive leaders, like warehouse automation, the company's growth prospects are most promising. However, by acquiring Intelligrated, a leading robotics company that complements Honeywell's small handheld and voice recognition portfolio, Honeywell has improved its competitive position. Products like personal protective equipment and high-risk safety gear, which have significant intangible assets like brand awareness and a reputation for dependability, are sold in mature markets by a portion of IA.The narrow moat that Honeywell's building automation segment enjoys is based on switching costs and intangible assets. As a result of its more than 100 years of operation, Honeywell has established a solid reputation with customers and a portfolio of brands that contractors are well-versed in. Many of Honeywell's building products are essential to the company's operations but only make up a small portion of the overall budget. Due to the fragmented competitive landscape of building products, buildings host a large number of different suppliers, and switching costs are typically lower than in highly regulated markets like aerospace. Due to increased product fungibility, Honeywell's market share is constrained.
Intrinsic Valuation
It is estimated that Honeywell's true intrinsic value is $222.37. This is twenty times the adjusted EPS estimate for 2025. In the second half of 2026, Honeywell is anticipated to separate its automation and aerospace businesses, which could enhance capital allocation and give each company more room to grow. Over the next five years, the company is anticipated to generate organic top-line growth in the mid-single digits by taking advantage of opportunities such as automation in the warehouse and commercial building sectors. Commercial aviation aftermarket growth is anticipated to be fueled by the ongoing shortage of narrowbody aircraft, and supply chain reshoring may increase demand for Honeywell's building and warehouse products.
Investment Downsides
Sales at Honeywell are largely dependent on short-cycle markets, such as manufacturing, oil and gas, and commercial construction, which can be postponed during economic downturns. Honeywell's organic sales volume decreased by 14% and 12%, respectively, during the most recent economic downturns in 2009 and 2020. Honeywell's yearly organic sales volume growth over the last 20 years, 10 years, and 5 years was, on average, 0.9%, negative 0.3%, and negative 2.4%. Price increases for top-line growth and margin expansion, as well as share buybacks for EPS growth, have resulted from the slowdown. Secular trends like automation, increased safety and emissions regulations, the expansion of the middle class in developing countries, and deteriorating US infrastructure all point to Honeywell's potential for growth in sales volumes.However, there is growing concern about the risk of obsolescence in the BA and IA segments due to rapid technological changes. Businesses in more recent, rapidly evolving sectors are susceptible to sudden disruptions. In the past, Honeywell has been sued for asbestos and legacy environmental issues, and the US Department of Justice has looked into allegations of bribery.In the upcoming years, Honeywell's operating margin is anticipated to grow at a nearly double-digit compound annual growth rate and a segment profit margin in the mid-20s. Honeywell is anticipated to produce long-term returns on invested capital that surpass 20%, with an estimated cost of capital of 8.1%. The company's EBI growth rate can be in the mid- to high single-digit range, which is marginally higher than its historical growth rate.
Portfolio Management
Despite having a solid balance sheet, Honeywell's unfocused operations have caused it to underperform the market. Due to the company's intricate organizational structure, numerous acquisitions have failed, resulting in a collection of dissimilar business units. The company's complicated structure hinders its best businesses, like building automation and aerospace. Honeywell should concentrate on making small, bolt-on acquisitions within its strongest businesses, even though its recent M&A activity is good. On the plus side, Honeywell is streamlining its digital and physical presences and selling off non-core operations, like the five retail footwear brands it owned before selling them to Rocky Brands, Inc. in 2021 for $230 million. To increase operational efficiency and highlight Honeywell's top businesses, management intends to spin off the company's Advanced Materials business unit.Honeywell has decreased its share count by 1.3% annually over the past 20 years, with the goal of reducing it by at least 1% annually through opportunistic buybacks. It's still unknown why these repurchases occurred. Given its maturity and limited reinvestment potential in core markets, Honeywell's recent dividend payout ratio of about 50% is appropriate. The company's dedication to increasing its dividend annually, however, may take funds away from potential investments.
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