Honeywell - Look Here for Growth

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Honeywell (NYSE: HON) is getting a pick up from its Good Industries, enough of a lift to maintain positive sales and earnings momentum into 2013.

It is a good time to be a diversified conglomerate. With GDP down in global markets, though, it is harder to juggle risk among global businesses. Proving once again that it is a solid operator, Honeywell's businesses held their own in the third quarter. Four of its five business segments grew margins. On flat sales of $9.3 billion year-over-year, operating margins were up 3.6% to 13.9%.  Earnings per share were up 9% to $1.20, while free cash flow increased 11% to $1.02 billion.

When global GDP starts to pick up in 2013 and beyond, Honeywell's Good Industries are well positioned to drive growth. Fifty percent of Honeywell's portfolio is linked to energy efficient technologies. The Good Industries are benefiting from the macro-trends of energy efficiency and clean energy generation, and include biofuels, energy retrofits, dieselization, refining technologies, and turbocharging.

On the short-term horizon, growth in some of Honeywell's Good Industries are slowing with global economic growth. Looking out farther, all are well positioned for growth in 2013 and beyond.

The economic drag, evident in sales in the third quarter, was offset by cost cutting and restructuring. In automation and control solutions, sales were flat at $3.96 billion and profit was up 5% to $571 million.

Building, Solutions, and Distribution sales were up 5%.  In the energy retrofit market, however, sales are slowing. While green building is a long-term growth market, the economy and more complex regulatory and funding requirements have slowed down activity in energy retrofits. Longer term, the company expects the business to continue to exhibit healthy growth. Sensing and control sales were also down, another group with sales linked to the Good Industries. Sales in scanning and mobility were up with the help of new product innovations.

A look at the performance of competitor Johnson Controls (NYSE: JCI) helps to strip out growth prospects in the green building sector. Johnson saw expected demand in the institutional sector (public sector, health, education) fall 15% in the quarter. This demand will begin to pick up with the economy in 2013. China has not stopped buying green building technology, and continues to generate strong demand. Johnson Controls' operating margins at 4.24% were squeezed more tightly than the more diversified Honeywell's. The ability to reduce costs by reducing energy consumption will be a pervasive driver in the building efficiency segment. The energy efficiency retrofit market is expected to almost double from $80.3 billion in 2011 to $151.8 billion in 2020, according to Pike Research.

Going back to Honeywell, in Performance Materials energy processor UOP is a bright spot. Revenues were up 7% on strong order backlog going into the third quarter. UOP is benefiting from an increase in shale gas deposits and gas consumption abroad. Both trends create higher demand for its process technology and equipment by the oil and gas processing industries. Honeywell started the fourth quarter better positioned for growth in the natural gas liquids (NGL) market by taking a 70% stake for $525 million in Thomas Russell, which specializes in the recovery of natural gas liquids. Energy companies are actively exploring and increasing production in gas and oil shale deposits. NGL demand is expected to increase at about 3% a year, with demand growth as high as 4% to 6% in China and India, according to IHS Chemical. Alongside this production, demand will be high for natural gas processing services.

Transportation revenue was down 10% in the quarter.  Turbo engines led growth in the quarter. The demand for more fuel efficient engines will drive turbo engine demand from 30% to 36% of the engine market in 2016, according to Honeywell Transportation CEO Alex Ismail, who forecasts double digit growth in North America and China. The company expects light vehicle gas penetration to double globally over the next five years. Competitor Borg Warner (NYSE: BWA) had a tougher quarter. Profits declined 28.6% to $101.1 million, or $0.85 a share, partly on a decline in light vehicle sales in Europe, which was down 6%. Western European diesel sales were flat for Honeywell. Low gas prices are increasing the competitiveness of cleaner burning gas engines.

Another trend working in Honeywell's favor is people clocking more air miles. Commercial aerospace sales were up as Boeing and Air Industries purchased more parts, creating overall healthy demand in commercial jet sales, with growth led by air transport and business jets. For the aerospace division, sales were up 4% to $3.04 billion. Profit was up 9% to 582 million. The commercial activity helped to offset declines in defense spending. Competitor United Technologies (NYSE: UTX), in contrast, feeling the defense cut in its helicopter business and having a lower commercial cushion from lower demand for parts, cut its 2012 sales forecast. Its $16.5 billion acquisition of Goodrich Corp. helped to boost third quarter profits 6.9% to $1.42 billion. Apparently, Honeywell, Pratt & Whitney is winning some market share from competitor GE (NYSE: GE) in Airbus parts.

The tougher operating environment has showcased Honeywell's operating strength.  The company has a price-to-earnings (P/E) ratio of 19.76 times – compared with around 15 times for many of its competitors – and a price to earnings growth (PEG) ratio of .96. The PEG compares to competitors GE and United Technologies at 1.22, and Borg Warner at 1. Since all these stocks have acceptable fundamentals – some revenues, profitability, and reasonable margins – let's look at the Sharpe ratio to determine which is the riskier asset. In other words, how much excess return are you receiving relative to the risk you are holding? The Sharpe ratios for Honeywell, GE, United Technologies, Borg Warner and Johnson Controls are 0.32, -0.12, 0.28, 0.05, 0.12, respectively. The higher Sharpe ratio is another positive measure of Honeywell's operating performance. It is taking less risk to generate its earnings.

In an operating environment in which global GDP is down from 3.9% in 2011 to 3.5% in 2012, Honeywell has managed to keep sales buoyed and earnings charged. It is adeptly picking up GDP growth where it can. In China, for example, it is targeting higher growth second and third tier cities. Going into 2013, it has an improved cost structure following austerity measures, including fixed cost reductions and ongoing restructuring projects. Projected GDP growth of 4% will further charge earnings growth in the coming year. The Good Industries portfolio is well positioned to lead this growth. Honeywell is increasing its dividend 10% in the fourth quarter. 

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric Company. Motley Fool newsletter services recommend BorgWarner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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