Honeywell Earnings Preview: Strong Growth In ACS To Overshadow Sluggish Aerospace Performance

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Honeywell

Honeywell International (NYSE:HON) is set to announce its third quarter results for the year 2014 on October 17, 2014. We expect to see low to mid single digit growth in revenues for its third quarter driven by strong growth in its Automation & Control Solutions (ACS) and Performance Materials & Technologies (PMT) divisions. The Aerospace segment may continue to present headwinds due to low defense spending in the U.S.

Revisiting second quarter 2014

In the second quarter 2014, Honeywell’s revenue grew 6% year-on-year, to reach $10.25 billion, [1] driven by strong growth in its Automation & Control Solutions and Transportation Systems divisions. The Performance Materials & Technologies division also made significant contribution to the revenue growth. Honeywell’s Aerospace division reported flat growth due to lower U.S. defense spending. Net income and earnings per share grew 8% driven by a 60 basis points increase in segment operating margins.

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One of the highlights of the second quarter earnings was the completion of divestiture from the Friction Materials business (a part of the Transportation Systems division) and the integration of the remainder of the Transportation Systems and Aerospace divisions. Honeywell has revised its revenue guidance down from 4% to 3% growth for 2014. However, due to the expected synergies between the Aerospace and Transportation Systems divisions, it revised its segment operating margins up by 10 basis points.

See our complete analysis of Honeywell here

Aerospace revenues may continue to present headwinds

Lately, Honeywell’s D&S sales have suffered due to the decline in U.S. defense spending, which accounts for 75% of its D&S sales. In 2013, Honeywell’s D&S sales declined 5% due to a 7.2% decline in U.S. defense outlays due to the impact of sequestration, as well as the winding down of the war in Afghanistan. [2] In the previous quarter, Aerospace revenues remained flat at $2.9 billion primarily due to a 1% decline in Defense & Space (D&S) sales, which offset the 1% growth in commercial aftermarket sales. [3] U.S. defense outlays are projected to decline 5% in 2014, which will continue to have a negative impact on Honeywell’s D&S sales.

The moderation in the decline of Honeywell’s D&S sales does offer some comfort. The 1% decline in the second quarter D&S sales was a vast improvement from the 8% decline witnessed in the first quarter. Additionally, growing D&S sales in the international markets could partially offset the decrease in Honeywell’s D&S sales in the U.S. International D&S, which accounts for 25% of Honeywell’s overall D&S sales, grew 9% in the previous quarter. It is expected to continue to grow during the second half of 2014 as many countries, other than U.S. and Russia, have been actively voicing their intentions of increasing defense spending.

Another aspect impacting Honeywell’s Aerospace revenue and margin is the integration of the Transportation Systems division. We expect to see some improvement in Aerospace margins driven by the synergies between Honeywell’s turbochargers business and Aerospace division. However, we also expect to see a decline in revenue since the Friction Materials business will not be a part of Aerospace revenues due to its divestiture. Friction Materials contributed around 18% to Transportation Systems revenue.

As we can see, there are a number of trends impacting Honeywell’s Aerospace revenues in the third quarter. However, there are more factors exerting downward pressure than upward. Therefore, we expect to see either flat or negative growth in the division’s revenue for the third quarter.

Intermec likely to drive Automation & Control Solutions growth

Honeywell’s Automation & Control Solutions division has been growing at high single digits mostly due to its acquisitions. We believe that in the third quarter the same trends will continue to drive high single digit revenue growth. In the second quarter 2014, Honeywell’s Automation & Control Solutions division grew 10%, to reach $3.6 billion. Of the 10% growth, 7% came from Honeywell’s acquisition of Intermec, [4] a leading provider of mobile computing equipment, radio frequency identification (RFID) scanners and tags, bar code scanners, and printers. With the acquisition, Honeywell has been able to increase its market share in the scanning and mobility industry through Intermec’s vast product line.

The demand for RFID and barcode scanners and tags has been growing due to the demand for efficient means of data collection. RFID and barcode technologies are being increasingly adopted by the retail industry for tagging clothes and keeping account of sales and inventory. These trends are expected to drive growth in the global Automatic Data Capture industry at an average rate of 12.29% per year through 2016. [5] This should continue to boost Honeywell’s sales of scanning products, which in turn will drive revenues for its Automation & Control Solutions division.

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Notes:
  1. Honeywell’s Second Quarter 2014 Earnings Release, July 18, 2014, www.honeywell.com []
  2. An Update to the Budget and Economic Outlook: 2014 to 2024, August 2014, www.cbo.gov []
  3. Honeywell’s Q2 2014 10-Q SEC Filing, July 18, 2014, www.honeywell.com []
  4. Honeywell International’s (HON) David Cote on Q2 2014 Results – Earnings Call Transcript, July 18, 2014, www.seekingalpha.com []
  5. Global Automatic Data Capture Market 2012-2016, October 15 2013, www.technavio.com []