We Expect to Raise Our Fair Value Estimate of Honeywell
publication date: Nov 4, 2020
author/source: Brian Nelson, CFA
By Brian Nelson, CFA
With GE’s (GE) fall from grace years ago, Honeywell (HON) has taken the reigns as one of Valuentum’s top industrial ideas. That said, we don’t include Honeywell in any newsletter portfolio given weakening fundamentals and an increased net debt position, but it remains top of mind should our existing holdings start to register ratings on the Valuentum Buying Index that may start to point to some profit taking. Honeywell yields just north of 2%.
We continue to expect our newsletter holdings to perform relatively better against a strengthening economic backdrop, and that means for us, Honeywell will remain on the bench. During Honeywell’s third quarter, results released October 30, its revenue fell 14% on a year-over-year basis, its operating margin dropped 250 basis points, an adjusted earnings per share came in at $1.56 per share (down 25% from last year).
Without a doubt, Honeywell is feeling the pain from a global pandemic that has hurt demand, but visibility is improving. Honeywell’s management reinstated financial guidance and now expects a full-year organic revenue decline of 11%-14% and adjusted diluted earnings per share in the range of $7.00-$7.05 (down 14%). The company is pursuing aggressive cost take-outs and plans to hit savings of ~$1.5-$1.6 billion during 2020. Several pockets of its operations have also shown resiliency. Demand in the areas of defense and space, warehouse automation, and personal protective equipment remains strong, the latter undoubtedly bolstered by the COVID-19 pandemic. Recurring software sales advanced at a double-digit pace organically.
Shares of Honeywell have rocketed higher from the March 2020 bottom and are trading at about 25x 2020 adjusted earnings numbers, which are depressed due to pandemic-related challenges. With some the dust settling from the COVID-19 fallout, we now have a better idea of what the future may hold for the company. At 18x $8.41 in diluted 2019 EPS (a normalized approximation), ~$150 per share might be a good fair value estimate for the equity. At the end of the third quarter, Honeywell held $18.2 billion in total short and long-term debt and $15 billion total cash and equivalents, so its balance sheet remains liquid, despite the net debt position.
As many members know, we very much prefer large net cash positions in new idea generation such as those held by many of our newsletter portfolio constituents--so Honeywell comes up a bit short in this area (but not by much). The company remains a diversified industrial with a very attractive aerospace aftermarket business, but it is an industrial nonetheless, and therefore will be heavily tied to cyclical tendencies, unlike many newsletter portfolio holdings that are levered to secular trends. Sales in Honeywell’s aerospace business, for example, fell 25% on an organic basis during the third quarter as flight hours dried up. Dividend growth investors, however, can look to 10+ years of consecutive dividend growth at Honeywell.
We may have been a bit too conservative with our latest fair value change of Honeywell in light of our expectations of the impact of COVID-19 on its business. Heading into the COVID-19 crash, our fair value estimate for Honeywell had been north of $150, and we expect to revise it modestly higher than that mark upon the next update of our valuation model. In light of COVID-19, we plan to apply a wider fair value estimate range, too, and that should put shares as fairly valued. Honeywell is our favorite industrial idea, but it remains on the bench in favor of better-positioned net-cash-rich powerhouses currently in the newsletter portfolios.
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Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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