What’s Driving Honeywell’s Aerospace Segment Going Forward?

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Honeywell’s (NYSE: HON) Aerospace segment accounts for 40% of Honeywell’s revenues and forms around 43% of our $106 price estimate for Honeywell. The segment manufactures aircraft engines and equipment, and offers services such as maintenance, repair and overhaul for commercial and defense sectors. In 2014, Honeywell’s Aerospace segment has been performing well on the commercial front, but its sales to the Defense and Space sector have been facing downward pressure due to low U.S. defense spending.

The Aerospace segment has undergone some restructuring of late, resulting in the consolidation of its turbochargers business, which was earlier a part of the Transportation Systems segment. Turbochargers have been gaining a lot of popularity in automobiles due to their high efficiency and low emissions, leading to mid-single digit growth in 2014. In this article we take a look at the factors impacting Honeywell’s Aerospace segment in the coming years.

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Commercial Original Equipment and Aftermarket

Honeywell’s Aerospace segment generates around 46% of its revenues from sales to commercial original equipment manufacturers (OEMs) and aftermarket components. In the past few years, the segment has benefited from higher consumer spending driven by a recovery in the global economy. With an increase in air travel, aircrafts have had to endure more wear and tear, raising the need for maintenance and repairs. For Honeywell’s Aerospace segment, this has translated into higher sales of aftermarket components and maintenance, repair and overhaul (MRO) services. Sales of aftermarket equipment have also benefited from aircrafts being regularly upgraded with latest equipment so that they remain efficient. The trend is likely to continue to have a positive impact on Honeywell’s Aerospace aftermarket equipment and components in the coming years. Honeywell forecasts its Aerospace aftermarket sales to grow at an average rate of 5.7% through 2018. [1]

Sales to OEMs are largely dependent on supply contracts and growth in aircraft demand. According to Boeing, around 36,770 aircrafts will be delivered over the next 20 years, amounting to $5.2 trillion. [2] The demand for more fuel efficient aircrafts and expansion of fleets will drive this growth. Given that Honeywell’s clientele in the commercial aircraft sector is comprised of major players such as Boeing, Airbus, Lockheed Martin and COMAC, who have a significant lineup of deliveries through 2018, Honeywell’s commercial OEM sales are well positioned for future growth. Some of Honeywell’s supply contracts for aircrafts that are scheduled to be delivered through 2018 are Bombardier Lear 70/75, Bombardier CL350, Airbus A350, Embraer 450/500, Embraer E2, Boeing 737 Max and COMAC C919.

Defense and Space

The Defense and Space sector forms 30% of Honeywell’s Aerospace revenues and its primary customer is the U.S. Department of Defense, which accounts for 75% of Aerospace defense and space sales. [3] In 2013, Aerospace’s defense and space revenue declined 4.7% as a result of a 6.6% decline in the U.S. defense outlay. [4] [5] U.S. defense spending declined 4.7% in FY 2014 [6] and will likely decline in FY 2015 as well, though with some moderation, which will likely continue to impact Aerospace’s defense and space revenue. Despite the decline in U.S. defense spending, Honeywell expects its defense and space sales to grow in the low single digits, primarily due to growth in defense spending across the world, especially developing countries. [7] For example, the new government in India increased defense spending by 12% to $38 billion. [8] China also increased its defense budget by 12%, to $132 billion. [9] According to Honeywell’s estimates, global defense spending (excluding the U.S.) is expected to increase 2.5% in 2015, which will drive positive momentum in its defense and space sales.

Turbochargers

Sales of turbochargers account for 24% of Honeywell’s Aerospace revenue. Honeywell’s turbochargers can be found on automobiles manufactured by major manufacturers such as BMW, Audi, Volkswagen, Chevrolet, Ford and Mercedes.

Turbochargers can efficiently deliver an increase in vehicle performance while reducing fuel consumption and emissions. Therefore they 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. [10] 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. [11] 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.

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Notes:
  1. Honeywell 2014 Investor Conference Presentation – Part 2, www.honeywell.com []
  2. Boeing Long Term Forecast, www.boeing.com []
  3. Honeywell’s Jefferies Global Industrials Conference Presentation, August 14, 2014, www.honeywell.com []
  4. Budget Results for Fiscal Year 2013, October 2013, www.treasury.gov []
  5. Budget Results for Fiscal Year 2012, October 2012, www.treasury.gov []
  6. Budget Results for Fiscal Year 2014, October 2014, www.treasury.gov []
  7. Honeywell’s 2015 Outlook Conference Call Presentation, December 15, 2015, www.honeywell.com []
  8. India raises military spending, eases foreign investment limit in arms industry, July 2014, www.reuters.com []
  9. China Announces 12.2% Increase in Military Budget, March 2014, www.nytimes.com []
  10. Honeywell’s Deutsche Bank Global Auto Industry Conference Presentation, January 14, 2014, www.honeywell.com []
  11. Turbocharger Market by Vehicle Type, Fuel Type, Technology & Region- Industry Trends & Forecasts to 2019, August 25, 2014, www.marketwatch.com []