New Coverage Launch By Trefis: $107 Price Estimate For Honeywell International Inc. – Part 1

Honeywell International (NYSE:HON) is a diversified manufacturing and technology company, headquartered in Morristown, New Jersey, which was born out of a merger between Honeywell Inc. and Allied Signal in 1999. The company manufactures a wide variety a products that cater to retail consumers, businesses and governments. In the fiscal year ended December 31, 2013, the company generated $39.06 billion in revenues and $3.92 billion in net profits. ^[1] In the second quarter ended June 30, 2014, Honeywell’s revenue stood at $10.25 billion and net profits at $1.12 billion. ^[2]

We have broken down the company into the following divisions:

1. Aircraft & Automotive Components
2. HVAC, Safety & Security Products
3. Process Solutions & Performance Materials

In this article, we give you a brief overview of Honeywell’s Aircraft and Automotive components division and look at the key trends driving volumes and margins. We will be offering our insight on Honeywell’s other two divisions in the subsequent parts of our launch article.

We have a price estimate of $107 for Honeywell, which is approximately 15% above its current market price.

A Brief Overview of Honeywell’s Aircraft & Automotive Components division

Honeywell’s Aircraft & Automotive Components division refers to Honeywell’s reported segments – Aerospace and Transportations Systems. Honeywell’s Aerospace segment manufactures aircraft engines and equipment, and offers services such as maintenance, repair and overhaul for commercial and defense sectors. Honeywell’s Transportation systems segment manufactures turbochargers for automobiles. Earlier, the segment also offered brake shoes and pads for automobiles under its Friction Materials business. However, following a decision to focus on differentiated technologies and on businesses that are in line with its long-term plans, Honeywell sold its Friction Materials business in July 2014. The turbochargers business was then combined with Honeywell’s Aerospace division.

The Aircraft & Automotive components division accounted for 40% of Honeywell’s revenues in 2013 and forms 42.5% of our $106 price estimate for Honeywell. The segment generates around 46% of its revenues from sales to commercial Original Equipment (OE) and aftermarket aircraft markets. Some of its customers in the commercial aircraft sector are Boeing, Airbus, Lockheed Martin and COMAC. The Defense and Space sector forms 30% of its revenues and its primary customers are the U.S. Department of Defense and NASA. Honeywell’s turbochargers can be found on automobiles manufactured by major manufacturers such as BMW, Audi, Volkswagen, Chevrolet, Ford and Mercedes. Sales of turbochargers account for 24% of the division’s revenue.

Volume growth and merger of turbocharger business should drive margins

As per our calculations, the division’s EBITDA (Earnings Before Interest, Depreciation And Amortization) margin was around 19.6% in 2013. We expect the division’s margin to improve due to the merger of turbochargers business with its Aerospace segment. According to Honeywell, its turbochargers are based on technology similar to its aircraft engines. Therefore, the merger should yield cost synergies that will help improve margins.

An increase in production volumes should help reduce operating costs due to economies of scale. According to Boeing’s forecast, around 36,770 commercial aircrafts, amounting to $5.2 trillion, will be delivered over the next twenty years. ^[3] Given Honeywell’s exposure to the commercial aircraft market through its presence as a supplier to major aircrafts such as Airbus A320, Boeing 737 Max and COMAC C919, we believe that it should be able to gain a sizeable exposure to the expected growth in commercial aircrafts which could help drive its volumes, the impact of which will be reflected on its revenues and margins.

Honeywell’s margins will also benefit from the increase in volume due to the growing demand for turbochargers. Turbochargers can efficiently deliver an increase in vehicle performance while reducing fuel consumption and emissions, and therefore are an effective solution to the growing demand for fuel efficient vehicles that are compliant with the stringent emissions norms being implemented across the globe.  Honeywell forecasts global turbocharger penetration to increase from 30% in 2012 to 70% in 2020 driven by this trend. ^[4] The global turbocharger market is expected to grow at an average rate of 10.12% each year through 2019 driven by the increased use of turbochargers by manufacturers as they try to fulfill the demand for fuel efficient vehicles. ^[5] Since Honeywell is the leading turbocharger manufacturer in the world, its large market share positions it well to capture a major portion of the growth in the turbocharger industry.

On the flipside, Honeywell’s volumes and revenue could suffer due to sequestration in the U.S defense spending. The U.S. defense sector accounts for 75% of Honeywell’s Aerospace sales to the defense and space sector and therefore is heavily reliant on it. ^[6] In 2013, Honeywell’s Aerospace revenue declined 0.5% due to a 4.7% declined in its revenues from the defense and space sector as a result of a 7.2% decline in the U.S. defense outlay.  U.S. defense spending is expected to decline 5% in 2014, ^[7] which could have a negative impact on Honeywell’s revenues and volume in 2014.

(Read about Honeywell’s HVAC, Safety & Security and Process Solutions & Performance Materials divisions in the second part and third part of our article respectively, which will be published soon)

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1. Honeywell’s 2013 10-K SEC Filing, www.honeywell.com [↩]
2. Honeywell’s Q2 2014 10-Q SEC Filing, www.honeywell.com [↩]
3. Boeing’s Current Market Outlook 2014-2033, www.boening.com [↩]
4. Honeywell’s Deutsche Bank Global Auto Industry Conference Presentation, January 14, 2014, www.honeywell.com [↩]
5. Turbocharger Market by Vehicle Type, Fuel Type, Technology & Region- Industry Trends & Forecasts to 2019, August 25, 2014, www.marketwatch.com [↩]
6. Honeywell’s Jefferies Global Industrials Conference Presentation, August 14, 2014, www.honeywell.com [↩]
7. An Update to the Budget and Economic Outlook: 2014 to 2024, August 2014, www.cbo.gov [↩]