Earnings 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.
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 reported on their first quarter results for 2015 back on April 22nd. Earnings were $1.53 on sales of $9.5B. This beat on both top and bottom line estimates from Analysts of $1.50 and $9.37B. In addition to beating expectations, Honeywell also raised their lower end of guidance from $6.45 by ten cents, creating a range now of $6.55 - $6.70. While results and guidance were positive, and generally in line with how management approaches almost every quarter, the results received little fan fare. I see a few factors to this. The first is that this is what we've come to expect almost every quarter, though the ten cent guidance increase is a little better than usual.
The other two get a little more tricky. In the case of Honeywell, the stock price has been appreciating through the course of the last 45 days, running up into the quarter as the dollar has weakened some. People started predicting that numbers would be better than expected on less pressure from the dollar. So as the company reported numbers that reflected this change, they kind of yawned because that has been priced into the stock. Since this was the case, people looking for a pop got out, and others just stood pat, from what I can tell.
The final factor seems related to the fact that the analysts didn't seem completely thrilled with the quarter. I think I see two, maybe three factors to this. The first, more questionable one, is that I don't think they are as impressed with the growth that is being forecasted. I think they were hoping for more. I believe Honeywell's management team is being disciplined and cautious. Yes, the dollar is weakening some, but it won't take much to get it stronger again - it just takes a rate hike. Secondly, the rest of the world just doesn't seem to be taking off. While they may be completing the downward phase, I have a feeling things are going to move up slowly, similarly as they did for the US. Add to that a lot of short fuses that could disrupt growth and I think they're better off staying cautious for now. If they beat because they were too cautious, that's ok. The second factor I think plays into a more negative view is that margin improvement isn't doing very well right now. After buying up 8 companies last year, the process of finding and incorporating improvements are taking time. as such, margin expansion slows or deteriorates. The market as a whole recently has been rewarding those that improve margins. Since Honeywell has been doing that for years and are taking advantage of investment opportunities, I don't see this as the negative analysts might be playing it off to be. Also, the lack of margin expansion is directly tied to the costs of assimilating companies it's recently purchased. When that work is complete (and management commented on things being ahead of schedule), we're going to see those margins rise again. The final bit of push back people may come up with is that there was a significant share repurchase of over $1.15B during the quarter. I haven't seen the average price that they were able to purchase at, but the estimate I come up with is between 10 and 11 million shares were repurchased through this program. Again, providing my work is accurate, this would relate to a 2 to 3 cent increase in earnings over the quarter. To me, this means they still managed to meet or beat estimates, so why is this such a big deal? Yes, this repurchase is also a reason why the lower end was raised ten cents instead of maybe five, which is more the norm. I just don't see this as financial manipulation to improve earnings at this point. If others do, I guess I'd like to better understand why.
From what I can see, all of this results in a good, though perhaps not perfect, quarter. My thesis regarding this being best of breed in the industrial space, taking advantage of aerospace and auto strength continues. With the new guidance we've been given, I need to raise my earnings and price targets for 2016. I now expect earnings to come in at $6.55 and still believe this stock deserves a multiple of 18 or 19. This places the price target at $120 (conservatively), with room to go up to $125 comfortably should macro or market conditions get more favorable. I don't think I'd buy shares at this price, if you're looking to get in. I believe a pullback to $110-112 at a minimum should happen first.
Nothing on this site should be taken as advice, research, or an invitation to buy or sell any securities. All views expressed are solely of my own and I am not a professional money manager. Please consult with your financial adviser before taking any action in your own portfolio.
The other two get a little more tricky. In the case of Honeywell, the stock price has been appreciating through the course of the last 45 days, running up into the quarter as the dollar has weakened some. People started predicting that numbers would be better than expected on less pressure from the dollar. So as the company reported numbers that reflected this change, they kind of yawned because that has been priced into the stock. Since this was the case, people looking for a pop got out, and others just stood pat, from what I can tell.
The final factor seems related to the fact that the analysts didn't seem completely thrilled with the quarter. I think I see two, maybe three factors to this. The first, more questionable one, is that I don't think they are as impressed with the growth that is being forecasted. I think they were hoping for more. I believe Honeywell's management team is being disciplined and cautious. Yes, the dollar is weakening some, but it won't take much to get it stronger again - it just takes a rate hike. Secondly, the rest of the world just doesn't seem to be taking off. While they may be completing the downward phase, I have a feeling things are going to move up slowly, similarly as they did for the US. Add to that a lot of short fuses that could disrupt growth and I think they're better off staying cautious for now. If they beat because they were too cautious, that's ok. The second factor I think plays into a more negative view is that margin improvement isn't doing very well right now. After buying up 8 companies last year, the process of finding and incorporating improvements are taking time. as such, margin expansion slows or deteriorates. The market as a whole recently has been rewarding those that improve margins. Since Honeywell has been doing that for years and are taking advantage of investment opportunities, I don't see this as the negative analysts might be playing it off to be. Also, the lack of margin expansion is directly tied to the costs of assimilating companies it's recently purchased. When that work is complete (and management commented on things being ahead of schedule), we're going to see those margins rise again. The final bit of push back people may come up with is that there was a significant share repurchase of over $1.15B during the quarter. I haven't seen the average price that they were able to purchase at, but the estimate I come up with is between 10 and 11 million shares were repurchased through this program. Again, providing my work is accurate, this would relate to a 2 to 3 cent increase in earnings over the quarter. To me, this means they still managed to meet or beat estimates, so why is this such a big deal? Yes, this repurchase is also a reason why the lower end was raised ten cents instead of maybe five, which is more the norm. I just don't see this as financial manipulation to improve earnings at this point. If others do, I guess I'd like to better understand why.
From what I can see, all of this results in a good, though perhaps not perfect, quarter. My thesis regarding this being best of breed in the industrial space, taking advantage of aerospace and auto strength continues. With the new guidance we've been given, I need to raise my earnings and price targets for 2016. I now expect earnings to come in at $6.55 and still believe this stock deserves a multiple of 18 or 19. This places the price target at $120 (conservatively), with room to go up to $125 comfortably should macro or market conditions get more favorable. I don't think I'd buy shares at this price, if you're looking to get in. I believe a pullback to $110-112 at a minimum should happen first.
Nothing on this site should be taken as advice, research, or an invitation to buy or sell any securities. All views expressed are solely of my own and I am not a professional money manager. Please consult with your financial adviser before taking any action in your own portfolio.
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