Still 15% Upside For Honeywell?

Honeywell stock (NYSE:HON) lost more than 42% – dropping from $180 at the beginning of the year to below $105 in late March – then spiked 41% to around $148 now. That means it has partially recovered to the levels where it started the year.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March helped the markets stage a strong recovery. Further, with economies opening up gradually, demand for Honeywell’s products and services will likely pick up. In addition, the company posted better than expected Q2 results, though the aerospace business is expected to remain weak in the near term.

But is this all there is to the story?

Not quite. Despite the recent rally, Trefis estimates Honeywell’s Valuation at about $174 per share, roughly 17% above the current market price based on two key opportunities and a near term risk.

The first opportunity we see is to Honeywell’s Revenue growth over the coming years. With the economies gradually opening up and lockdown restrictions being lifted in several cities, the Boeing 737 Max production is expected to pick up pace, boding well for Honeywell. Boeing in a press release stated that it will gradually increase manufacturing of 737 Max to 31 planes a month by 2022, after the production was suspended in Dec 2019. The earlier production rate was 57 a month in 2019. Other than Aerospace, the company’s Building & Safety products will also see an uptick in demand over the coming years, as the deferred purchases in the company’s security, fire and building management systems come in.

The second opportunity we see is to Honeywell’s Expenses, which have been trending lower, when looked at as a percentage of revenue, over the past few years. Honeywell has been focused on reducing its expenses, and it decided to de-consolidate its low-margin Transportation Systems, and Building Products business, which unlocked more value for its shareholders. The company is now focused on higher margin businesses, including Aerospace and Healthcare. While the Aerospace business in particular is facing challenges in the current pandemic, it should benefit from growing commercial and military production in the long run.

Finally, Honeywell’s valuation is attractive compared to its own historical levels. The stock now trades at 18x its 2019 adjusted earnings per share of $8.16. In comparison, to earn close to $8 per year from a bank, you’d have to deposit about $800 in a savings account today (assuming 1% interest rate), which is about 100x desired earnings. At Honeywell’s current share price of roughly $150, we are talking about a P/E multiple of around 22x based on expected 2020 adjusted earnings of $6.89, and we think a figure closer to 25x will be appropriate. While the 25x number appears high compared to levels seen over the recent years, it is due to the fact that 2020 EPS will likely be lower given the impact of Covid-19. The estimated adjusted EPS of $6.89 in 2020 compares with $8.16 and $8.01 figures seen in 2019 and 2018, respectively. With the revenue expected to grow sequentially over the coming quarters, clubbed with margin expansion due to better product mix and cost cutting measures, this will result in strong earnings growth over the coming years. In fact, we estimate the 2021 adjusted EPS to be $7.90 per share, and at the current price of around $148, HON stock is trading at just 19x 2021 (expected) earnings.