Expect M&A And Operational Efficiency To Drive Earnings Growth Going Forward For Honeywell

Honeywell (NYSE: HON) reported third quarter earnings for fiscal 2015 on Friday, October 16th. The company’s sales slipped again (this time by 5%), due to foreign currency headwinds and lower pass-through pricing for resins and chemicals. ^[1] However, despite lower revenue, Honeywell maintained earnings  growth as its margins improved by 190 basis points, primarily due to reduced cost of sales. The reduction in expenses can be directly attributed to the company’s process initiatives such as the HOS Gold operating system that helped drive operational efficiency. While the company’s sales have fallen due to the weak macroeconomic environment, it is actively looking at mergers, acquisitions and divestitures to drive growth. We expect this to positively impact top line by approximately 15% – 20% through the company’s five-year plan.

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Mergers And Acquisitions Will Continue To Be A Key Part Of Honeywell’s Growth Strategy

After seeing revenues fall throughout 2015 as a result of weak macro environment, foreign currency headwinds and low pass-through pricing for resins and chemicals, the company is now focusing on M&A activity to strengthen its market position and drive growth. In little over a decade, Honeywell has added $12.0 billion in annual sales through 84 acquisitions. This strategy has helped it increase value for shareholders by 194%, more than double the growth posted by the S&P 500. We expect Honeywell to continue focusing on M&A, restructuring and divestitures in order streamline operations to focus on the most profitable and promising lines of business.  The company has committed $10 billion in acquisitions through 2018, and expects to add $5 – $8 billion in sales during the period. ^[2]

Recently, Honeywell announced the acquisition of Elster and expects to close it early next year. Elster is a provider of thermal gas solutions, and will add $2.0 billion in sales to Honeywell’s topline in the ACS (Automation and control solutions) and PMT (Performance materials and technology) segments. ^[3] Synergy opportunities lie in leveraging current channels and infrastructure. Elster’s gas heating assets, metering portfolio and presence in natural gas transportation and storage would strengthen Honeywell’s portfolio and drive sales growth.

HOS Gold To Drive Margin Expansion

The company’s Honeywell Operating System (HOS) Gold initiative has successfully expanded the company’s margins since its launch. The operating system helps increase operational efficiency through streamlining processes, better inventory management, product and software development, expert execution of operations and aggressive expansion strategies in high growth regions. In the third quarter, Honeywell’s segment margin expanded 190 bps to 19.3%, of which ~140 bps was driven by operational improvement on account of HOS Gold initiative, productivity and restructuring. It is an ongoing initiative and we expect operational improvements and cost containment to drive margins higher in the company’s five year plan through deployment of process enablers such as HOS (Honeywell operating system), VPD (Velocity Product Development), FT (Functional Transformation) and HUE (Honeywell user experience). Honeywell’s five year plan for 2014 to 2018 builds out a path to generate $46 – $51 billion in revenue and achieve 18.5% – 20.0% operating margin levels.

Global Flight Hours And Turbo Penetration Will Fuel Core Organic Sales Growth

Transportation systems sales were up 1.0% on a core organic basis, driven by new platform launches and higher gas turbo penetration on passenger vehicles. By 2020, Honeywell forecasts turbo adoption globally to reach 47% generating $12 billion in revenue, with increased demand for turbo technology innovations. ^[4] Sales are projected to be up 2% – 3% on core organic basis driven by light vehicle gas and diesel turbo volumes for the fourth quarter of 2015.

Commercial OE segment was up 4.0% on core organic basis following double digit growth in engine shipments. Growth in engine shipments can be directly attributed to factors such as growing flight hours, continued airline repair and overhaul activity. According to JSSI’s Business Aviation Index, global flight hours increased by 6.8% year over year in the first quarter of 2015. ^[5] The Index records 2015 to be the strongest year for flight hours post 2008 and expects this trend to continue through 2016. ^[6] With expected growth in flight hours globally, we expect the engine shipments segment to continue posting double digit growth driven by improving economic conditions in key business aviation markets globally.

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1. Honeywell reports third quarter earnings, Honeywell, October 16, 2015 [↩]
2. Honeywell outlines global growth strategy, Honeywell, March 5, 2015 [↩]
3. Honeywell Third Quarter Earnings Call Transcript, The Street, October 16, 2015 [↩]
4. Honeywell’s 2015 Turbocharger Forecast, Honeywell, September 16, 2015 [↩]
5. Global Business Aviation Recovery in Q1 2015, Jet Support Services Inc., May 14, 2015 [↩]
6. Global Business Aviation Recovery in Q2 2015, Jet Support Services Inc., August 11, 2015 [↩]