Here’s Why Honeywell Stock Is Overpriced At $215 Levels

Honeywell Stock (NYSE: HON) looks fully valued at current levels of $215, as it has gained 2x from the levels it was at on March 23, 2020, when broader markets made a bottom due to the spread of Covid-19. This marks an outperformance compared to the S&P which has moved 75% since its March 2020 lows, with the resumption of economic activities as lockdowns are gradually lifted and vaccination programs have been initiated in multiple countries. This outperformance can partly be attributed to better than expected quarterly performance in Q3 and Q4, as well as an increased expectation of strong earnings growth by investors. Looking at a longer time period, HON stock is up 63% from levels of around $132 seen toward the end of 2018.

Much of the 63% rise of the last 2 years or so can be attributed to the expansion of the P/E multiple, while earnings have actually declined. Honeywell’s total revenue declined 22% to $32.6 billion in 2020, as compared to $41.8 billion in 2018. The decline in revenue can be attributed to the pandemic as well as divestiture of its transportation systems business. Also, the company saw a 160 bps contraction of its net margins from 16.2% in 2018 to 14.6% in 2020, resulting in a 22% drop in net income from $6.8 billion to $4.8 billion over the same period. The company’s total shares saw a decline of 2% over the same period, and on a per share basis, earnings dropped 20% to $6.79 in 2020, as compared to $9.10 in 2018. Despite the lackluster performance over the recent years, Honeywell’s P/E multiple has expanded, and it will likely see a drop from the current levels. Our dashboard, ‘What Factors Drove 63% Change In Honeywell Stock between 2018 and now?‘, has the underlying numbers.

Honeywell’s P/E multiple expanded over 2x from 14.5 in 2018 to 31.3 in 2020, based on trailing EPS. While the company’s P/E is at around 32 now, it compares with levels of 14x in 2018, and 20x as recently as late 2019.

Outlook

Honeywell has seen a significant impact on its Aerospace business during the pandemic. A decline in overall passenger air travel  and cuts in capital spending by the airlines has meant lower revenues for Honeywell’s original equipment as well as aftermarket business. Investors, though, have been optimistic about this business as the economies open up gradually in 2021. Looking at the latest quarter, Honeywell reported a 19% y-o-y drop in Aerospace revenues, a trend which may take a while to reverse, in our view. Note that Aerospace is the largest segment for Honeywell, accounting for 38% and 35% of its total sales in 2019 and 2020, respectively. For Honeywell, its Safety & Productivity Solutions business came to the rescue in 2020, with increased demand for masks and PPE driving the segment sales higher (by 6% for the full year). Now, the decline in 2020 sales was expected for several businesses, and Honeywell was no exception with its exposure to Aerospace, which by the way, is also the most profitable segment for the company. While Honeywell will see sales growth as the Covid-19 crisis winds down, the overall revenue is estimated to reach just $36.6 billion by 2022, a little short of $36.7 billion levels seen in 2019. That said, the margins are expected to expand, resulting in a stronger earnings growth over the next couple of years. Given it will take a couple of years for Honeywell to bring its business back to pre-Covid levels, the sharp rise in its P/E multiple looks overdone, and we believe that the stock may be vulnerable to downside risk.