Honeywell (HON) reported third quarter profit gains of 16% on revenue of $9.3 billion which was also an increase of 6%. Shares are trading down more than 7% because the company narrowed guidance and lowered their full year revenue forecast. For those that follow HON, this should not be a surprise as the stock has been crushed already by these recession fears. Honeywell—down 51% year to date—has performed far worse than most of its diversified industrial peers which have fallen 24% on average. Furthermore, this recession has been on the mind of the HON management team, as CEO Dave Cote stated:
“While we are surprised by the extent of these tough times…I can’t say we are surprised they came. We have been preparing for that.”
In anticipation of operating difficulties, the company has been cutting costs by lowering discretionary spending and by implementing a hiring freeze. The company has sold off non-performing business segments such as the sale of the aircraft parts division to BE Aerospace Inc. (BEAV). What’s more, the company has a supremely diversified product set and has continued to emphasize growth in their aerospace and defense business lines. Profit slipped a bit (8%) in this division as Honeywell spent money developing and improving products which they anticipate will hedge them against a probable slowdown in their home building area. Despite the global slowdown, emerging market demand for airplanes continues to be strong. In 2008 Honeywell Aerospace forecast a record number of deliveries of business jets, nearly 1,200, up 20% with further growth projected next year.
As we all saw this morning, home starts continue to slip and are currently at their second lowest rate in 50 years. So, it was a bit of a surprise that the building controls unit (maker of thermostats, fire safety equipment, and the like) was the star of the earnings report with revenue growth of 15%. The automation and control unit was the largest in 2007 accounting for 36% of revenue, slightly edging out aerospace products and services with 35% of revenue.
So, there are certainly going to be some challenges ahead for Honeywell. However, the current market tendency has been to over react to just about every piece of news or guidance.
Let’s get some perspective here. Was there anything in the results that was unexpected? Honeywell issued conservative guidance which is prudent going into what could be a very difficult operating environment. The revised full year earnings guidance is $3.76 to $3.80, which if you will recall is simply a narrowing of previous estimates of $3.75 to $3.85. Also, keep in mind that they did beat estimates in this quarter as analysts polled by Thompson Reuters anticipated 95 cents per share, but actual results were 97 cents. The falling price of oil surely assisted the company in managing costs.
The merits of valuation analysis in this investing environment dominated by fear and uncertainty are debatable in the short term. However, such valuations are (at the very least) more informative and useful than reacting to news and price swings without a point of reference.
By standard valuation metrics Honeywell is clearly out of favor with the market. As sales have increased consistently, HON stock has gotten less credit for those sales as demonstrated by our price-to-sales analysis. Over the last 10 years, HON has normally traded in a price-to-sales range of .83x and 1.32x, but the current level is only .58. Also of note is that price-to-cash flow for Honeywell has oscillated in the range of 11.7x to 19.97x and right now that valuation metric is 5.6x. If the stock were to appreciate to just the price that would bring these historical metrics into line give current sales and cash, a share of HON would trade around $58.
So, ask yourself, “Were the 3rd quarter results bad enough to require an already depressed stock to continue to slide?” Did the market learn something that it did not already know? Ockham would have to say, “clearly not.”
The fear of recession was a large reason for the stock’s recent performance. We think that for those investors with a long term focus, a cheap and diversified stock with sales continuing to grow and a dividend yield approaching 4.0% may be appealing in this difficult environment.