What a difference a month or so makes. With investors happy to see Congress play kick the can with the fiscal cliff, industrial stocks have caught a second wind and done quite well over the last month. While Honeywell (NYSE:HON) is a quality industrial conglomerate that often seems to get overlooked, management's modest guidance for 2013 and the company's mediocre free cash flow history don't really argue for aggressively chasing these shares at this point.

SEE: Investing 101

Solid, Albeit Not Spectacular, Performance for Fourth Quarter
Honeywell reported a very respectable result for the fourth quarter of 2012. Management stayed true to form, however, in acknowledging some signs of end-market improvement, but maintaining guidance that on the whole looks fairly conservative.

Revenue rose 1% as reported and 1% on an organic basis. Automation and control systems (ACS) was the performance-leading division, with organic revenue growth of 3%. Aviation was a little softer than expected, with organic revenue down 1%. Performance materials grew 8% on an organic basis, while transportation dropped 11%.

Adjusted gross margin was basically flat with the prior year, while operating income rose about 9%. Segment-level profits rose a little more than 5%, with ACS logging a 10% improvement and aviation growing 5%, while performance materials and technologies (PMT) fell 6% and transportation dropped 20%. The good news, in brief, was that Honeywell saw the best performance from the segments that generally count the most.

SEE: 5 Must-Have Metrics For Value Investors

The Comps Get Interesting
Comparing Honeywell to some of its leading competitors produces some interesting data and deviations. While General Electric (NYSE:GE) saw good growth in its aviation business, Honeywell is far more exposed to defense (which fell 6%) and aftermarket parts, and that very definitely kept a lid on performance.

Honeywell's performance in ACS was also interesting. Honeywell definitely outperformed rivals like United Technologies (NYSE:UTX) and Johnson Controls (NYSE:JCI), helped at least in part by its exposure to security and environmental. Process solutions was soft, but still better than recent results from Parker Hannifin (NYSE:PH) or Siemens (NYSE:SI) might have suggested. It will be interesting, then, to see what companies such as Rockwell Automation (NYSE:ROK) and Emerson (NYSE:EMR) have to say about these markets, and likewise Tyco (NYSE:TYC) in its security business.

Transportation has also gotten very tough for Honeywell, with European light vehicle production down about 10% in the fourth quarter. Although BorgWarner (NYSE:BWA) and Honeywell's transportation business don't necessarily move in lock-step, they tend to go in the same direction at similar paces, so this doesn't suggest an especially strong quarter for BorgWarner.

Guidance Still Conservative
Honeywell tends to be a fairly conservative company, and that shows in the guidance. Management is looking for only low single-digit revenue growth this year, with good growth in PMT and decent growth in ACS pulled down by weakness in aerospace (due in large part to defense) and transportation. While it's tough to see how defense really surprises to the upside this year, it may not be as bad as was feared, while increased turbo penetration into the Chinese vehicle market could offer some upside.

Apart from that guidance, Honeywell still has ample room for improvement. The company's operating margins are not all that impressive relative to many other industrial conglomerates, and this explains a lot of the company's relative underperformance in free cash flow production. While bears could use that as a reason to avoid the shares, it also represents profit potential that could be unlocked down the road if management focuses on generating better returns.

SEE: 5 Stock Market Metrics Explained

The Bottom Line
As I have said earlier in this piece, there's a push and pull when it comes to Honeywell and its shares. The company likely could do better than it does, but how much credit do you give for potential? Likewise, while the company has some good market exposures, the overall growth profile doesn't look so impressive in the short term.

Assuming that Honeywell can generate high single-digit free cash flow growth (against mid-single digit performance over the past decade), these shares carry a fair value in the low $70s. That's not really enough to get me excited about these shares, particularly after their recent run.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
  4. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  5. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  6. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  7. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  8. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  9. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  10. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center