Valuentum Exclusive Analysis for the Discerning Investor

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On Wednesday, Honeywell (click ticker for report: HON) put up strong second-quarter results. The firm’s revenue jumped 4% from the same period a year ago, while earnings per share advanced 14%. The largest driver behind the strong performance in the period had to do with better cost management, as the firm’s segment margin jumped an impressive 150 basis points. Though the company lowered the range of its revenue outlook for 2012 modestly, Honeywell raised the low end of its bottom-line outlook for the year to the range of $4.40 - $4.55 per share (was $4.35 - $4.55) thanks to higher than previously expected margin expansion. Free cash flow jumped 5% during the quarter, though we note most of the increase was driven by lower capital expenditures as cash from operations dropped 14%. Honeywell maintained its free cash flow guidance of approximately $3.5 billion for the year, which represents 100% conversion of net income and 9.2% of expected sales. We were pleased with the industrial bellwether’s performance, but think the company’s shares remain fairly valued.

The company’s aerospace, automation/controls solutions, and PMT (performance materials and technologies) segments performed considerably well during the quarter, with both experiencing top-line and segment profit expansion. On an organic basis, revenue tied to the aerospace market jumped 7% thanks to an 18% increase in commercial end market growth, which was only partially offset by weakness in defense-related projects. The company noted that commercial aftermarket sales jumped 9% as both spares and repair and overhaul revenue expanded. Aerospace segment profit jumped 25%, as segment margins increased 260 basis points, to 18.6%. We continue to be big fans of the aerospace end market, and we reiterate our view that the industry is one with the greatest visibility thanks to the tremendous backlogs (7-8 times annual production) at the airframe makers.

In its automation/control solutions segment, sales edged up 2% (4% organic), and the firm was able to leverage that top-line expansion into 6% growth in segment profit, despite foreign exchange headwinds. Within this segment, Honeywell continues to benefit from new product introductions, international expansion, and trends toward improving safety, security and energy efficiency. The segment’s margin jumped 50 basis points from the same period a year ago, to 13.3%. PMT arguably was the biggest driver behind the company’s strong quarter, with segment revenue jumping 10% and segment profit expanding 25%. Impressively, PMT’s segment margin advanced 260 basis points, to 22.6% (a record).

Honeywell’s only weak spot in the quarter came from its Transportation Systems segment, where revenue and segment profit fell 9% and 12%, respectively. Within this segment, Honeywell remains exposed to significantly lower European light vehicle production volume and aftermarket sales as uncertainty and austerity measures pressure the region. Still, this segment is Honeywell’s smallest, and its weakness continues to be mitigated by the strong overall performance of the industrial conglomerate’s other segments.

All things considered, Honeywell’s second-quarter performance was solid. Though the firm remains fairly valued, we like its dividend-growth profile and exposure to pockets of strength in the global economic system. We’re also taking this report as yet another positive data point supporting the largest industry weighting in our Best Ideas portfolio, aerospace.