Honeywell: Spin Offs Allow the Company to Focus on High Growth Areas
Companies can spin off portions of its businesses for a variety of reasons. Perhaps a certain segment no longer makes sense within the company. Or perhaps a spin-off is done to appease shareholders.
Many times a certain business is spun off because it was holding the core business back. Honeywell International (HON) decided that two businesses were holding its core business back and spun them off in October.
Recent News and Most Recent Financial Results
Honeywell International completed two spin-offs near the end of 2018. The company spun off its Transportation business on October 1st. The standalone company, called Garrett (GTX), is a leader in cutting-edge technology that will enable automobiles to become more connected, safer and efficient. While a part of Honeywell International, this division generated $3.1 billion in revenue and $623 million in EBITDA in 2017. Through the first half of last year, Garrett had organic revenue growth of 7% and EBITDA margin of 20%. Revenues grew a little more than 3% in each of the last two years.
Honeywell International also completed its spin-off of its Homes & Global Distribution business into a standalone company called Resideo (REZI) on October 29th. Resideo supplies solutions in the areas of HVAC, security and electrical to name a few. This division allows consumers to connect a multitude of products, including air, heat, security and smart phones, in order to create a connected home. Resideo produced nearly $5 billion in sales last year, with sales split almost evenly between products and solution and distribution. Sales for the new company are expected to be about 6% higher on a year-over-year basis. Revenues for Resideo had grown at a rate of 4% from 2015 through 2017.
After removing these two businesses from the company, Honeywell International was left with four divisions: Aerospace, Building Technologies, Performance Materials & Technologies and Safety and Productivity Solutions.
Source: Honeywell International’s Third Quarter Financial Presentation, slide 5.
Honeywell International earned $2.03 per share in the third quarter, beating the market’s expectations by $0.04 and growing 16% year-over-year. Revenue improved 6.3% to $10.8 billion, right in line with analysts’ expectations. Organic growth company wide was 7%.
Each division of Honeywell International contributed to results.
Source: Honeywell International’s Third Quarter Financial Results Presentation, slide 13.
There are two areas that stand out, the first being Safety & Productivity Solutions. This division posted 12% organic growth, with Productivity Solutions being the main driver for this improvement. Honeywell International’s Intelligrated warehouse automation offerings were singled out by the company on the conference call as a catalyst for the double digit organic growth. Intelligrated products allow business to automate their warehouses, helping to heat, cool and move product quickly and efficiently. This also helps control costs. Honeywell International saw strong order growth which added to the company’s backlog. The continued rise in e-commerce and the fact that it is estimated that just 5% of warehouses in the U.S. are currently automated means that this division within Honeywell International is likely to see continued demand for products going forward.
The other standout division, and the one investors should focus on, is Honeywell International’s Aerospace division. Aerospace, which is the company’s largest division and accounted for ~38% of sales in the quarter, saw organic growth of 10%. Strength in unit demand for engines, avionics and auxiliary power led to 19% organic growth in commercial OE. Higher deliveries to both Boeing (BA) and Airbus were responsible for much of this growth.
This trend in higher revenue growth for Aerospace is in a midst of a very long cycle. With just 20% of the world’s population having taken a flight, air travel is expected to double over the next two decades as a middle class forms in emerging markets. Helping to illustrate this point is that 100 million Chinese citizens flew for the first time in 2017. Boeing forecasts that nearly 43,000 new airplanes will be needed during this time to accommodate this growing demand in air travel. Given this environment, Honeywell International’s Aerospace division is likely to see high levels of growth in the coming years.
Also important to note is the 14% organic growth that Honeywell International’s Defense & Space segment produced during the quarter. Higher volumes on the F-35 and CH-47 Chinook programs contributed to this figure as did increased guidance systems demand. Again, defense revenues should continue to be a source of strength as spending on defense increased to $700 billion for fiscal 2019 in the U.S. This total is expected to grow in future years as well.
Accounting for the spin-off of Garrett and Resideo, Honeywell International lowered its earnings-per-share guidance to $7.98, down from $8.10 previously. If achieved, this would represent more than 12% growth from 2017. Based off of Wednesday’s closing price of $131.03, shares trade with a price-to-earnings ratio of 16.4. By comparison, the price-to-earnings ratio of the S&P 500 is 19.3.
With more of a focus on areas of strength, Honeywell International should be able to continue to pay and raise its dividend. Though the company hasn’t cut its dividend in more than two decades, it has paused its growth from time to time. The most recent pause took place from 2009 to 2010. Honeywell saw earnings-per-share decline by almost a third from 2008 to 2009, so a pause was a wise choice on the part of management during this adverse time for the world’s economies. Once earnings growth returned, so did dividend growth. The company has increased its dividend:
- By an average of 13.6% per year over the past three years.
- By an average of 12.4% per year over the past five years.
- By an average of 10.6% per year over the past ten years.
Honeywell International increased its dividend by 10.1% for the payment made on December 7th. This marks the eight consecutive year that the company has increased its dividend. Shares currently yield 2.5%, higher than the 2.1% yield of the S&P 500.
Shareholders received $3.06 dividends per share in 2018. Using the company’s earnings-per-share guidance of $7.98 for the year, this equates to a payout ratio of 37.8%. The company’s ten-year average payout ratio is just over 36%, so the dividend isn’t consuming all that much more of earnings than it has in the past. This makes it highly likely that Honeywell International will continue to pay and raise its dividend even if earnings-per-share suffer a decline.
Honeywell International has guided towards a free cash flow midpoint of $6 billion for 2018. Cash flow in the third quarter improved more than 50% to $1.8 billion in the third quarter. Through the end of the third quarter, the company had spent $4.5 billion of its cash flow on dividends ($1.7 billion), share repurchases ($2.3 billion) and acquisitions ($500 million). Honeywell International expects to return all $6 billion to shareholders in 2018.
Honeywell International has decided to slim itself down, spinning off two different businesses into standalone entities. While these businesses offered decent growth rates, they pale in comparison to the company’s core business.
Honeywell International has pockets of strength amongst its different businesses, but it is the Aerospace division that will likely power the company’s future. Aerospace should have a long cycle of growth in front of it and Honeywell International’s largest component should produce strong results over that time.
The stock also has a below market valuation, an above market dividend yield and a very low payout ratio. That dividend should continue to grow as management appears committed to returning capital to shareholders. Investors looking for exposure to the aerospace sector should consider adding shares of Honeywell International to their portfolio.