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.

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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/>.