Stock Analysis: Honeywell (HON)

Notes:
Stock Ratings: 1 = buy at current stock prices, 2 = buy on a 5-10% dip in stock price, 3 = sell on a 5-10% increase in stock price, 4 = sell at current stock prices to raise cash.  Ratings are based upon 12-18 month outlook on stock direction and not necessarily related to moves I make due to financial positioning.

Honeywell presented their first quarter results on Friday.  While they were able to beat earnings expectations by two cents, coming in at $1.41, they missed revenue expectations, reporting only $9.2B.  Earnings were up in large part due to a 2.2% increase in segment margin. The company raised the lower end of their guidance by five cents, indicating they feel things are continuing to look good, despite the lighter sales.  

With a mixed quarter like this, I see some good and some not so good items worth noting.  I'll start with some of the concerns and risks the stock faces.  To start with, they missed on revenues.  January was a very bad month, and though it doesn't seem to be something that was specific to the business or industry, it's still concerning to see how much things stalled out in that month.  The stall had significant impact in the expected organic growth projections for the year, taking what was anticipated to be about 5% organic growth on the year down to about 3% instead.  That's a bit concerning and it's also starting to draw question whether the company can hit its 2018 goals for organic growth of 4% - 6% annually.  To sum this all up, Foreign exchange is expected to have a $1.7B impact on revenues for the year.  The low levels of free cash flow compared to a year ago is also a little concerning, though it does seem to fit within their original plans.  The other piece is that there continues to be little in regards to M&A activity.  CEO Dave Cote explained that at this time, prices are too high and he intends to wait until he finds value.  When they reach a cash position that allows them to make acquisitions, they'll use excess cash to be returned to shareholders.  Returning excess cash to shareholders is good, as opposed to holding it, though it may not be as lucrative a deal compared to making acquisitions that can help accelerate and grow sales and earnings numbers as planned.

While the above might seem like a lot of bad news, there is good news and/or counterparts to many of the items above.  First, while sales and organic growth was down, the company was able to increase earnings 10% compared to a year ago and segment margin was in excess of what was expected.  The company's currency hedging strategy has been fruitful and could return twelve to thirteen cents to shareholders, compared to not executing it.  Likewise, they've managed to position themselves that if they're struggling to meet organic sales growth, they're out performing on margins and therefore are still hitting their 2018 double digit earnings growth strategies.  This positioning allows them to still be on target or better on the year in free cash flow, income, and margins.  Organic growth will be less than expected, but still positive, and revenues will be down from 2014 mostly due to currency conversion rates.  In all, management is confident they're still on target for their year and 2018 goals, overall - all despite the challenges the lackluster GDP growth rate across the worls and strong US dollar provide.  Additionally, to maintain the positive impact on their income, they're already working to hedge 2016 foreign exchange prices.

So what does all of this mean for the stock?  That depends, in part, on your timeline, I think.  I feel like the overall market may be entering into a time similar to that of 2011/2012.  Back then we had European events, in particular, spooking the market.  Right now we have some of those same pressures combined with fear from the middle east, earnings impacts due to foreign exchange rates, and overall stock evaluation as you look at world-wide GDP appearing to slow and the US facing a Fed whom everyone feels certain will start increasing rates this year.  The market is volatile right now and I expect the stock to play in line with that activity.  Over the next 3-6 months, I don't expect a lot of price appreciation (though it would be welcomed), and actually see risk for the stock to fall below $100 - especially if the market has more days like Friday.  I also see a market pulling back to be something positive for the company in the long run, because that will likely bring down prices of potential acquisitions that the management team would then pounce on.  In the long run, I see no real issues with the stock or its story at this time.  For those that want to hold the stock long-term, don't pay attention to the short term action.  Focus on what the company delivers, assure they are delivering, and buy up at good prices if we get them due to an overall market sell off.  A company that is consistent, well managed, and delivers as Honeywell has for the past 5+ years while delivering 10% or more earnings growth deserves a multiple in the range of 17 to 20.  The price as of Friday's close is just under 17 times earnings.  This means the stock is just starting to enter into valuable discount territory.  I maintain my 2015 earnings estimate to be $6.12 and that they deserve an 18 multiple.  The price target stays at $110.