Honeywell Earnings: Lower Costs, Higher Margins Drive Earnings And Outlook

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Honeywell’s (NYSE:HON) stock rose 1.4% on Friday, as the company reported better than expected earnings on account of lower costs, which helped improve margins. Honeywell’s productivity improvement initiative, HOS Gold, and restructuring efforts were also driving factors behind the improved margins. The earnings growth is all the more impressive since it came despite the heavy decline in revenue, which was negatively impacted by foreign exchange headwinds, the Friction Materials divestiture and resin and chemicals pricing. With the expectations of margin improvement, Honeywell raised the lower end of its annual earnings per share guidance from $6.0–6.15 to $6.05-6.15. However, its top line guidance remains within the range of $39.0-39.6 billion.  ((Honeywell Reports Second Quarter 2015, July 17, 2015, Honeywell’s Press Release))

Honeywell reported a 9.4% increase in earnings per share to reach $1.51, compared to market estimates of $1.49 per share, while its revenue dropped 4.5%, to $9.78 billion.

See our complete analysis of Honeywell here

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Margin Growth Aided By HOS Gold, Lower Costs, Friction Materials

Honeywell’s segment margin expanded 170 basis points to 18.4%, tracking 20 points higher than the upper end of its guidance. [1] The primary reasons behind the massive improvement have been Honeywell’s HOS Gold initiative and lower costs. Honeywell’s HOS Gold initiative is a management system that builds upon its predecessors, HOS Bronze and Silver, and aims at increasing operational efficiency by streamlining processes, better inventory management, product and software development, expert execution of operations and aggressive expansion strategies in high growth regions. [2] The HOS Gold management system helped drive 110 basis point growth in segment margins. [3] Lower costs, as a consequence of declines in energy prices, also helped.

Since HOS Gold is an ongoing initiative and will continue for the foreseeable future, we expect to see continued improvement in Honeywell’s margins as it continues to pursue the strategy. Though the low energy price environment is not a permanent phenomenon, it is likely to continue through the medium term and drive lower operational costs for Honeywell.

Another contributing factor towards margin growth was the divestiture of Honeywell’s Friction Materials business, which was earlier a part of its Transportation Systems segment. The business accounted for 18% of the company’s annual Transportation Systems’ revenues and was divested in July 2014, following the company’s decision to focus on differentiated technologies and businesses that are in line with its long-term plans. Due to its significant contribution to revenues, its divestiture led to a significant negative impact on Aerospace revenues in the second quarter. However, it added 20 basis points to segment margin growth. [3] Honeywell claims that the improvement in segment margins as a result of the divestiture should be permanent.

ACS Drives Organic Top Line Growth

Honeywell’s Automation and Control Solutions’ (ACS) reported revenue was down 1% in the second quarter as a result of foreign exchange headwinds. [1] The segment generates 48% of its revenues from outside the U.S. However, on an organic basis, which excludes the impact of foreign exchange fluctuations, the segment grew 4%, the strongest of Honeywell’s three segments. The primary driving factor behind this growth was Honeywell’s Scanning and Mobility business, which grew double digits for the third consecutive quarter, due to the mobile delivery device contract that the U.S. Postal Services had awarded Honeywell last year.

A part of Honeywell’s HOS Gold strategy, which is to aggressively pursue expansion in high growth regions, also contributed to ACS’ top line growth. Sales of Honeywell’s scanning, mobility, fire, safety and security products grew high single digits in China and mid-teens in India.

Going forward, we expect to see continued growth in Honeywell’s ACS segment as the rising demand for scanning and mobility products and strength in the global economy fuels sales. Honeywell’s ACS segment will also benefit from its acquisition of Datamax-O’Neil, a manufacturer of fixed and mobile printers used in the retail, warehouse and health care industries. The acquisition, which was completed in March, positions Honeywell to expand into the $1.5 billion global bio-code printing industry.

Solstice Products Demand Continues To Rise

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. [4] At the second quarter earnings meeting, Honeywell announced that it continues to see strong demand for these products and has already signed agreements worth $3.2 billion, with an additional $200 million which is likely to be finalized by the end of 2015. [5] This should help offset the expected weak performance from Honeywell’s Performance Materials and Technology segment due to headwinds from low crude oil prices.

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Notes:
  1. ref:1 [] []
  2. Honeywell 2015 Investor Conference – Part 1, March 4, 2015, Honeywell’s Presentations []
  3. Q2 2015 Honeywell Earnings Conference Call Presentation, July 17, 2015, Honeywell’s Presentations [] []
  4. Honeywell Starts Full-Scale Production Of Low-Global-Warming Propellant, Insulating Agent, And Refrigerant, January 6, 2015, www.honeywell.com []
  5. Honeywell International’s (HON) CEO David Cote On Q2 2015 Results – Earnings Call Transcript, July 17, 2015, Seeking Alpha []