Wall Street has turned very positive on industrial conglomerate Honeywell (NYSE:HON), to the tune to of a market-beating 12% rise over the past quarter and a 44% rise over the past year. Certainly there are reasons to like Honeywell – the company's commercial aerospace is well-positioned for global growth, as is the building controls business. What's more, years of investments in the performance materials business should start paying off soon. Even so, there's a limit to what any business is worth, and it seems like Wall Street's enthusiasm has sent the shares above that limit.
A Relatively Familiar Theme So Far
It's still early in the reporting cycle for the big industrial companies, but I'm starting to think that “okay on revenue, better on margins” may end up being the theme. Although like General Electric (NYSE:GE) Honeywell did not beat on its revenue number, the solid margin performance drove a bottom line EPS beat.
Revenue rose 3% as reported this quarter. The Automation and Control business generated 3% organic growth, with all of the components showing year-on-year growth. Performance Materials was strong at 9% growth, and Transportation was pretty solid at 5% growth. Aerospace was more mixed, with 1% organic growth coming from solid commercial growth (up 8% for original equipment and 3% for aftermarket) offset by continued weakness in defense (down 8%).
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As I said, margins were pretty good. Gross margin improved a point, and operating income rose 8%. Overall corporate operating margin improved by 60bp, with aerospace and ACS each seeing roughly one-point margin improvements. Margin declined more than three points in PMT, due to lower licensing sales, lower Advanced Materials volumes, and costs tied to the Thomas Russell deal.
Wins Will Drive More Revenue Growth
Honeywell continues to rack up contract awards that should help fuel the top-line growth that the Street already expects. On the commercial aviation side, it's not just about production growth at Boeing (NYSE:BA), as Honeywell has won some significant contracts from foreign aerospace companies including Embraer (NYSE:ERJ) and China's COMAC.
It's not just aerospace where Honeywell is doing well. The company's UOP segment recently won a gas processing equipment order from Petrobras (NYSE:PBR) for four offshore floating production projects. As many analysts had penciled in Cameron (NYSE:CAM) for this business, and Cameron has been talking up its technological capabilities in this business, this is an interesting win for Honeywell even if the dollar amounts ($100 million over two years) aren't all that significant to Honeywell.
Will Honeywell Go For Invensys?
Honeywell has been a willing acquirer for a number of years, but a new target is on the radar right now. Schneider has approached Britain's Invensys with a buyout offer, and the company is now in play. Invensys may not be a household name, but the company is a significant player in the industrial/process automation sector, and is particularly well known for its industrial software.
Several companies have been named as potential counter-bidders, including Emerson (NYSE:EMR) and GE, but Honeywell may be interested as well. A bid for Invensys would be digestible for Honeywell, but it would still be a large acquisition and it would definitely alter the company's end-market exposures. While I think Honeywell would love to get the industrial software business, I think the challenges of integrating a large deal and improving Invensys's below-average will probably keep the company on the sideline.
The Bottom Line
I like everything about Honeywell except the price, though I'm perfectly willing to acknowledge that the stock could easily continue to head higher if the company stays ahead of estimates and the market stays bullish on the global industrial recovery theme.
For now I continue to model 4% long-term revenue growth and 10% free cash flow growth for Honeywell. With those growth rates, I believe fair value is in the $70s, and so I'm not inclined to add these shares to my own portfolio today.
Disclosure – As of this writing, the author owns shares of Cameron.