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Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 1
Recommendation: BUY Target Price until (12/31/2015): $115
1. Reasons for the Recommendation
Honeywell’s diversified segment operations allows the company to remain profitable year after year and
not become completely susceptible to struggling market conditions around the world. The company has
performed above expectations so far in 2014 and has managed to produce favorable organic growth in
their Automation and Control Solutions and Performance Materials segments. Honeywell’s decision to
merge their Transportation Systems segment with their Aerospace segment will also allow the company
to focus on the three segments that have been the most profitable for the company. The company has
displayed strong cost management with the implementation of their new Honeywell Operating System
(HOS) and functional transformations.
Honeywell’s Aerospace segment should continue to experience moderate growth due to favorable
Commercial Original Equipment (OE) and Aftermarket (AM) sales over the next five years. OE and AM
sales should provide moderate returns due to strong Air Transport (AT) build rates as well as an increase
in Business & General Aviation (BGA) shipment rates. BGA growth has rebounded in Europe and plans
to lead all regions despite softness in certain areas. Honeywell is well positioned due to strong OE
positions in China, Russia, and Brazil as well as rapid airline growth in the Middle East, Turkey, and
Indonesia.
Defense and Space (D&S) revenue has a favorable outlook with international growth and government
services stabilizing. International defense budgets are projected to see growth over the next five years due
to an increased demand in Maintenance, Repair, & Operations (MRO), modifications and upgrades
focused on safety and efficiency, and several large procurements (Trainers, Helicopters, & Fighters).
Honeywell also maintains a strong international position in Israel with the countries trainer jets as well as
with Korean and Turkey missile programs. International sales make up a large percentage of Honeywell’s
aerospace revenue and should continue to do so with the company’s involvement in diversified platforms
around the globe.
In our opinion, military conflict around the world is something that will not conclude anytime in the near
future. The demand for military air support and weaponry, especially by the United States and our closest
allies will continue to be volatile. Also, we assume that threats like ISIS and similar terrorist groups could
immediately change the landscape for the defense industry. Therefore, defense spending would likely
increase as demand for protection from new found threats rise and jeopardize the security and well-being
of U.S. citizens.
Honeywell’s Automation and Control Solutions segment has also experienced revenue gains due to fire
and industrial safety growth, continued residential strength, and non-residential improvements. The
segment has experienced organic growth at a significant rate and should continue to bring in favorable
revenues for the company. Honeywell’s ability to continually improve comes from successfully achieving
productivity and growth. The company’s global processes such as Six Sigma and Honeywell Operating
Systems (HOS) drive efficiency and service quality. Honeywell’s automation and smart technology are
used by families, businesses, and communities around the world. The company’s Building Systems
Design (BSD) also continues to see distribution strength around the Americas.
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 2
Honeywell has reported to its investor’s favorable earnings through 2014 and over the next five years.
Earnings per share as well as potential dividends are attractive to investors due to continued growth over
the next five years. Honeywell’s Board of Directors announced on October 31, 2014 they have approved a
15% increase in the company’s regular annual cash dividend rate. The dividend rate will increase from
$1.80 per common share to $2.07 per common share starting with the fourth quarter dividend. The
company is in-line with five year targets and favorable macro trends for market expansion.
Honeywell will need to maintain a strong global footprint to maintain a steady growth in revenue over the
next five years to offset U.S. Department of Defense Government Services declines. The U.S. makes up
nearly half of Honeywell’s revenues with Defense and Space the majority of sales. Honeywell is also
expecting flat growth in its Performance Material segment in Q4 2014 which is a sign that Universal Oil
Product (UOP) sales and services remain volatile around the globe. Volatility is mainly due to tough
competition and slow growth in some markets and can possess unfavorable growth for the industrial
conglomerate.
2. Company Analysis
Strengths
Honeywell has assembled a very strong leadership team with David Cote, Honeywell’s CEO, who took
charge in 2002. Under his leadership the company’s stock price has increased by 223.5%. By way of
comparison the Dow Jones and the S&P 500 only had growth rates in the 50% range (Donlon). Mr. Cote
gained a lot of experience working for General Electric. He worked his way to the top during a 20 year
career and then transitioned over to TRW where he became the Chief Operating Officer. In 2013 he was
voted Chief Executive Officer of the year in poll conducted by Chief Executive Magazine.
Honeywell has a good team in place for the board of directors. Gordon M. Bethune has extensive
management expertise from key leadership positions at both Continental Airlines and the Boeing
Company. He also has a wealth of experience in aircraft manufacturing, financial services, marketing and
branding. D. Scott Davis from UPS has significant expertise in management strategy, finance and
operations. George Paz from express scripts has extensive experience in risk management, mergers and
acquisitions, capital markets and government regulations.
Honeywell plans to use their cash flow from operations on growing the company and increasing
shareholder returns through 2018. The company reported to investors at the Morgan Stanley Laguna
Conference in September of this year that they plan on using 50% of their cash flow to grow the company
in the form of capital expenditures and M&A. Honeywell has been using a disciplined valuation and
screening process in order to target $10 billion in M&A. Honeywell will use the remaining 50% toward
share buy backs and shareholder returns in the form of dividends. The company reports that they will
spend roughly $5 billion to hold share count (Morgan Stanley Laguna Conference). On October 31 of this
year, Honeywell also announced that the company will increase their dividend payout by 15% to $2.07
beginning with 2014’s fourth quarter (Financial Release).
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 3
Honeywell’s successful operations can also be attributed to their Honeywell Operating System (HOS) that
was implemented in 2004. HOS has enabled Honeywell to become one of the most successful companies
in multiple industries. Honeywell’s profits have more than doubled since the introduction of the HOS due
to huge improvements in productivity. Honeywell now has the ability to produce some products up to
four times faster due to HOS (The HOS Reports Flourishing Success).
Weaknesses
The Defense budget sequestration of 2013 showed that Honeywell is vulnerable to defense spending
reductions. In the third quarter of 2013 Honeywell said that they had lost about 11% of its sales in their
aerospace segment due to the sequestration. Cote is “planning for a continued slow growth macro
environment” as he looks to the future for Honeywell (Black).
Opportunities
The expanding market has created some new launches for Honeywell products. There are a variety of new
airframes that will be using Honeywell products from the Aerospace segment. New launches for
propulsion engines, auxiliary power units, safety systems, and cockpit systems are projected to result in a
CAGR of 5-6% over the next five years (Bolton). Other new opportunities are projected in Europe where
they are expecting 6% growth in the market, especially in the area of larger aircraft for the public sector.
Accelerated growth across key regions due to globalization will help Honeywell meet their five year
targets. Universal Oil Products (UOP’s), Process Solutions, and the innovation of Advanced Materials
can catapult Honeywell toward record sales. The company’s Performance Materials segment is expanding
in Asia, South America, Africa, and Europe. Honeywell may collect nearly 50% of their total revenues
internationally by 2018 from this segment (Performance Materials And Technologies Investor
Conference).
Threats
Honeywell has had problems in the past with lawsuits for things like asbestos. Honeywell is in the
process of shutting down its friction material business and this may be a part of that decision. New
lawsuits continue to be added claiming that Honeywell was responsible for clients being diagnosed with
Mesothelioma.
The latest threat is a new lawsuit filed by the EEOC. This is because Honeywell wants to look at a few
risk factors as part of its wellness program, but the EEOC claims that Honeywell has gone too far.
Honeywell is looking into test things like blood (a blood draw), blood pressure, cholesterol, BMI, and a
nicotine test. The concern is that the information would be used to deny people insurance and that
Honeywell is making these tests mandatory or the employee could face a $4,000 fine.
Update: On the 14th of November 2014 a U.S. District Judge in Minnesota denied the EEOC’s request to
block the Honeywell from assessing the health insurance-related surcharges (Honeywell Fends Off
EEOC).
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 4
3. Industry Analysis
Aerospace
The Aerospace/Defense industry operates with two specific markets. The Aerospace market is comprised
of production, sales, and aircraft services. The Defense market is based on our military’s demand for
weapons and specific systems used to defend our nation. General aircraft mostly used for business
purposes is another product that is produced in the Aerospace industry. Other products in demand by
Honeywell include space vehicles such as satellites that are for military and commercial use.
The Aircraft Engine and Engine Parts industry has managed to bring in $181.3 billion in revenue through
2014. Over the next five years to 2019, revenues for this particular industry are projected to increase by
3.5% annually to $215 billion. Heavy demand around the world for commercial aircraft will fuel growth
but defensive budget cuts may offset increases. Mergers and Acquisitions (M&A), especially in the
supply chain, will be expected as well since increased interests are handled well when suppliers have the
ability to handle industrial demands.
The majority of revenue brought in from this industry is through exporting manufactured goods.
Approximately 62.9% of industry revenue is made from commercial airline sales to foreign airlines and
parts distributors. 26.4% of revenue is sales to the U.S. Government and U.S. civilian sales make up
10.7% of revenues.
The Aircraft, Engine and Engine Parts Manufacturing industry is experiencing a medium to high level of
market concentration. Defense is less concentrated and dominated by only a few firms. Barriers to entry
in this industry is high due to the existence of companies that already possess the proper technology and
experience (Competitive Landscape).
Automation and Control Solutions
The automation and control solutions sector manufactures and provides services in industries such as
Thermostat Manufacturing, Electronic Access Control Systems, and Process Control Instruments. The
products manufactured in these industries include environmental and combustion controls, security and
life safety, process automation, control systems, and scanning and mobility.
Residential and nonresidential building sectors are the largest markets for the thermostat manufacturing
industry. New home construction has progressed over the last few years which has fueled revenue growth
due to the increased demand for home appliance purchases. 2014 has been a favorable years for
companies within the industry.
Industry growth is projected to continue in the next five years since increased construction requires higher
volumes of automation controls for new homes and commercial buildings. Also, the growing demand for
automation controls that are more energy efficient will fuel revenue growth and increase profits. New
innovations will also become popular with consumers and services as technology advances within the
industry. Strong demand is projected to increase revenue at an average annual rate of 2.9% to $3.8 billion
in the next five years to 2019 (Industry Outlook).
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 5
The Thermostat Manufacturing industry has a moderate level of market share concentration. The
industry's largest four operators are expected to account for almost 50.0% of 2014 revenue. Honeywell is
the major player in the industry and is estimated to account for 38.1% of revenue in 2014.
Performance Materials
The Personal Protective Equipment Manufacturing industry is projected to experience strong growth over
the next five years as downstream activity continues to rise and employers purchase products that comply
with workplace safety standards. Moreover, growth in the construction sector is expected to accelerate,
leading to higher overall demand for industry products. Appreciation of the US dollar, however, will
exasperate rising import competition. Overall, industry revenue is projected to increase at an average
annual rate of 2.4% to $3.1 billion over the five years to 2019.
Beyond domestic markets, companies will likely continue to look to foreign markets for revenue. This
trend will occur as growth in key demand sectors in foreign nations outpaces growth in the United States.
Additionally, emerging economies will likely introduce sweeping safety and workplace reforms as they
industrialize. As a result, manufacturers will have tremendous opportunities to develop protection
equipment products that suit new nation-specific and international standards and regulations.
The Personal Protective Equipment Manufacturing industry bears a high level of market share
concentration. Roughly 70.3% of industry revenue will be acquired by the industry’s top four firms to
include Honeywell (Market Share Concentration).
Appendix: Inputs into valuation using multiples
2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014F 2015F
Stock Price 61.57 32.83 39.20 53.16 54.35 63.47 91.37 102.50 114.58
Diluted EPS 3.16 3.76 2.85 2.59 2.35 3.69 4.92 5.50 6.15
Sales 34589 36556 30908 33370 36529 37665 39055 40300 41500
Sales per Share (diluted) 45.24 49.62 41.07 42.73 46.15 47.56 48.98 50.76 52.53
Price/Earnings 19.48 8.73 13.75 20.53 23.13 17.20 18.57 18.64 18.64
Price/Sales 1.36 0.66 0.95 1.24 1.18 1.33 1.87 2.02 2.18
* Sales in millions
* Shares in millions
* Analyst’s own calculations. Source of basic data: company's 10-K; Yahoo! Finance
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 6
Works Cited Black, Thomas. “Honeywell Reduces Full-Year Sales Forecast Amid Defense Cuts." Bloomberg. 18 Oct.
2013. Web. 01 Nov 2014. Bolton, John. Honeywell.com. Gabelli & Company Aircraft Suppliers Conference Presentation.
09/09/2014. .pdf. 01 Nov 14. Donlon, JP. “Chief Executive Magazine Names Honeywell CEO David Cote 2013 CEO of the Year." CEO
Briefing Newsletter., 31 May 2013. Web. 01 Nov 2014. Competitive Landscape. 2014. 25 November 2014 .
<http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/competitivelandscape.asp
x?entid=842>.
Competitive Landscape. 2014. 25 November 2014.
<http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/competitivelandscape.asp
x?entid=4216#MSC>.
Financial Release. 31 October 2014. 25 November 2014.
<http://investor.honeywell.com/phoenix.zhtml?c=94774&p=irol-newsArticle&ID=1984283>.
Honeywell Fends Off EEOC Bid to Bar Wellness Penalty. 4 November 2014. 25 November 2014.
<http://www.bloomberg.com/news/2014-11-03/honeywell-fends-off-eeoc-bid-to-bar-wellness-
penalty.html>.
Industry Analysis: Aerospace and Defense. 2014. 31 October 2014.
<http://www.valueline.com/Stocks/Industries/Industry_Analysis__Aerospace_and_Defense.asp
x#.VFaHnfnF-So>.
Industry at a Glance. 2014. 31 October 2014.
<http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/ataglance.aspx?entid=537
1>.
Industry Outlook. 2014. 25 November 2014.
<http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/industryoutlook.aspx?enti
d=5371>.
"Investor Presentations." 24 October 2014. Honeywell. PDF. 31 October 2014.
<http://investor.honeywell.com/phoenix.zhtml?c=94774&p=irol-presentations>.
"Morgan Stanley Laguna Conference." Morgan Stanley Laguna Conference. 2014. .PDF. 25 November
2014. <http://investor.honeywell.com/phoenix.zhtml?c=94774&p=irol-presentations>.
Honeywell (HON)
Analysts: Ian Scott & Nicholas Alderete Fall 2014
pg. 7
"Performance Materials And Technologies Investor Conference." Performance Materials And
Technologies Investor Conference. 2014. .PDF. 25 November 2014.
<http://investor.honeywell.com/phoenix.zhtml?c=94774&p=irol-presentations>.
Personal Protective Equipment Manufacturing. 2014. 31 October 2014.
<http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/industryoutlook.aspx?enti
d=4216>.
The HOS Reports Flourishing Success. 13 May 2012. 25 Novemeber 2014. <http://better-
operations.com/2012/05/13/the-honeywell-operating-system-hos-reports-flourishing-
success/>.
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