Honeywell Earnings: OEM Incentives, Friction Materials Divestiture Dampen An Otherwise Strong Performance

Honeywell International (NYSE:HON) announced its fourth quarter and annual results on Friday, January 23. As a result of the Friction Materials divestiture, original equipment manufacturer (OEM) incentives and currency headwinds, the company reported a 1% year-on-year decline in its fourth quarter revenue. ^[1] However, on an organic basis, which excludes these factors, Honeywell’s revenue grew 4%. Its annual revenue grew 4%, tempered by the same factors, while benefiting from the Intermec acquisition. Annual revenue grew 3% on an organic basis, since this excludes the impact of consolidation of Intermec’s revenues.

Honeywell reported a sluggish 1% increase in its fourth quarter earnings per share to reach $1.20. However, excluding mark-to-market pension adjustments, earnings per share grew 15%, to reach $1.43, beating expectations of $1.42. On the revenue front as well, Honeywell beat analyst expectations of $10.21 billion by $60 million. Though Honeywell’s earnings and revenue beat analyst expectations by very narrow margins, investors took to it kindly, driving up Honeywell’s stock by 3.1%.

Of Honeywell’s three reported segments, only the Automation and Control Solutions (ACS) segment reported growth. Revenue of the Aerospace segment, which manufactures aircraft and automotive components, declined due to Friction Materials and OEM incentive headwinds. Performance Materials and Technologies revenue remained flat due to strong dollar exchange rates. For the full year 2015, Honeywell forecasts a 1-2% year-on-year increase in revenues and 7-11% increase in net profits, assuming a tax rate of 26.5%. ^[1] Its earnings per share guidance is of $5.95-6.15, which excludes any mark-to-market pension adjustment.

See our complete analysis of Honeywell here

OEM Incentives, Divestiture Drive Down Aerospace Revenues

Honeywell provides sales incentives to commercial aircraft manufacturers and airlines when they select Honeywell’s aircraft equipment. These incentives consist of free or deeply discounted products, purchase credits and upfront cash payments. These costs are recognized either as cost of products sold or a reduction to sales in the period incurred. In the fourth quarter, Honeywell recognized a $184 million reduction on its revenue as a part of OEM incentives, which led to a 14% decline in its sales to commercial aircraft OEMs. ^[2]

Aerospace fourth quarter revenue declined 6% on a reported basis due to the OEM incentives and Friction Materials divestiture. ^[1] Honeywell divested from the Friction Materials business in July 2014. On an organic basis, Aerospace revenue was up 4% due to primarily due to sales related to the Bombardier Challenger 350 and Embraer Legacy 500, strong aftermarket spares growth and demand for turbochargers.

For the full year, Aerospace reported a 1% decline in revenues, again primarily due to the Friction Materials divestiture and OEM incentives. Weak currency headwinds and defense and space sales also impacted revenue growth. Going forward, we expect the impact of the Friction Material divestiture to continue through the second quarter of 2015. However, the impact will likely be partially offset by continued growth in sales to original equipment manufacturers and aftermarket as the demand for air travel and efficient aircrafts continues to grow. Aerospace sales to the defense industry will also likely grow as defense spending in emerging markets such as India and China rise. Additionally, growing demand for turbochargers and their penetration in vehicles should help boost Honeywell’s turbocharger sales. (Click here for a detailed review of our outlook on Honeywell’s Aerospace segment)

Scanning And Mobility Drives ACS Revenues

Honeywell’s ACS segment benefited from strong growth in sales of its scanning and mobility products. This was primarily driven by its acquisition of Intermec, 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. Growth in residential and non residential construction in the U.S. helped boost sales of safety, security and climate control products. Housing starts in the U.S were up 8.8% year-on-year for 2014 and construction spending increased 8.2% year-on-year for the year to date ending November 2014. ^{[3] [4]}

Going forward, we expect to see continued growth in Honeywell’s ACS segment. Sales of the segment’s safety security and climate control products will likely grow as housing starts are expected to increase 17.1% in 2015. ^[5] Additionally, the Architecture Billings Index (ABI), a leading indicator for nonresidential construction activity in the U.S., was in positive territory for the ninth consecutive month in December, giving rise to expectations of continued growth in nonresidential construction in 2015. ^[6]

Honeywell’s ACS segment will also benefit from its acquisition of Datamax-O’Neil, a manufacturer of fixed and mobile printers used in retail, warehouse and health care industries. The acquisition, which is expected to be completed by the first quarter of 2015, positions Honeywell to expand into the $1.5 billion global bio-code printing industry.

Solstice Products Receive High Demand

In September 2014, Honeywell announced that it will increase production of its low GWP refrigerants, insulation materials, aerosols and solvents. To this end, it started full-scale production of its Solstice line of low-global-warming materials at the Honeywell Fluorine Products facility in Baton Rouge on January 6. ^[7] At the fourth quarter earnings meeting, Honeywell announced that it had seen strong demand for these products and has already signed agreements worth $2.3 billion, with many more under negotiation. ^[8]

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1. Honeywell’s Fourth Quarter 2014 Financial Release, January 23, 2015, www.honeywell.com [↩] [↩] [↩]
2. Q4 2014 Honeywell Earnings Conference Call Presentation, January 23, 2015, www.honeywell.com [↩]
3. New Residential Construction, December 16, 2014, www.census.gov [↩]
4. US Construction Spending Chart, www.ycharts.com [↩]
5. NAHB Housing and Interest Rate Forecast, January 5, 2015, www.nahb.org [↩]
6. AIA Architecture Billings Index, www.aia.org [↩]
7. Honeywell Starts Full-Scale Production Of Low-Global-Warming Propellant, Insulating Agent, And Refrigerant, January 6, 2015, www.honeywell.com [↩]
8. Honeywell’s (HON) CEO David Cote on Q4 2014 Results – Earnings Call Transcript, January 23, 2015, www.seekingalpha.com [↩]