Is It Time For Honeywell To Finally Shine?

As one of the world’s top manufacturing and engineering conglomerates, Honeywell International (NASDAQ:HON) makes everything from cockpit displays for aircraft to home thermostats.

The company’s shares are currently trading at one of their lowest price-to-earnings ratios since 2020, which could mean either earnings are headed in the wrong direction or Honeywell is on sale, which is it?

Bulls Can Point To Margins & Top Line Growth

In Q3, Honeywell reported 3% year-over-year revenue growth. Aerospace sales, up 18% for the year, were a key driver of this growth.

Honeywell’s connected enterprise business, which focuses on digital innovation, also outperformed the broader company by delivering 20% YoY top line growth.

Earnings per share were essentially flat at $2.27 versus $2.28 in the year prior. Management has forecast earnings of between $9.10 and $9.20 per share for the full year, representing an annualized growth rate of between 4% and 5%.

Even though the bottom line failed to impress, a positive sign for the future stems from an increase in the backlog of orders which were $31.4 billion by the end of Q3, an increase of 8% from the previous year. 

Margins also appear attractive. In Q3, operating margin reached 20.9%. Net margin over the past year has been 14.9%, while return on equity has been a very favorable 34.6%. Overall, Honeywell has generated a trailing 12-month net income of $4.97 billion on sales of $35.47 billion.

Solidifying the bulls thesis is Honeywell’s Q3 earnings that beat analysts’ estimates despite being essentially flat versus a year ago. Analysts had predicted earnings of $2.23. Although this beat was not massive, it is the latest in a string of positive earnings surprises that has been unbroken since 2021.

Is Honeywell Stock Undervalued?

According to 21 analysts, Honeywell is 10.3% undervalued with a median price target over the next 12 months of $212 per share. This figure is in lockstep with the $214 fair value calculation that results from a discounted cash flow forecast analysis.

At 23.3 times trailing earnings and 20.9 times forward earnings while trading at 17.8x cash flow, Honeywell stock appears to trade at quite reasonable multiples.

But it’s not all sunshine and roses when it comes to valuation as the PEG ratio sits at an astonishing 7.28x, meaning relative to future earnings growth, Honeywell is expensive.

Slowing Revenue Growth Poses A Threat

While management has done a good job of raising margins and, by extension, bottom-line earnings, the company has not seen the kind of significant revenue growth that one might expect from a dominant blue-chip enterprise.

As good a job as management has done squeezing out profits, the question does arise how much incremental earnings can be captured without a climb in revenues.

In light of Honeywell’s high price-to-earnings-growth ratio and modest long-term revenue growth projections, the threat of market underperformance is significant.

With that said, EPS is forecast to rise at a compounded annual growth rate of 7.8% over the next five years, which may be just enough to keep HON share price on an upward trajectory.

For longer term investors, it’s worth zooming in on the company’s debt and paying attention to it over coming quarters given the persistent spike in rates. The company’s debt-to-equity ratio is 0.94, and its long-term debt has crept up considerably in recent years.

At the end of 2019, Honeywell’s long-term commitments totaled $11.1 billion. Today, that number has risen to $16.7 billion. As a result of this heavy debt load, Honeywell incurred $206 million in interest and other financial charges in the most recent quarter, up from $98 million a year ago.

What You Should Know About Honeywell

Honeywell is the world’s fourth-largest conglomerate, meaning it enjoys significant competitive advantages in terms of both scope and scale. It also permits the company to pay a handsome yield to patient shareholders.

Each share of Honeywell pays $4.32 annually, translating to a dividend yield of 2.27%. Notably, the company has raised this dividend in each of the last 13 years, and the compounded rate of annual dividend growth over the past decade has been 8.9%.

The current dividend payout ratio for Honeywell is 53.5% so management has a reasonable amount of room to amplify the yield in the coming years.

One catalyst to a rising yield will be rising long-term earnings bolstered by ongoing investments in electrification and other new technologies. The company’s avionics systems, for example, will feature prominently on new generations of light electric aircraft for commercial passenger transportation.

Honeywell’s Q3 connected enterprise growth also shows off the company’s potential for leveraging new digital technologies. 

Final Thoughts

Honeywell’s major drawback is its relatively limited overall revenue growth. Although improvements in operational efficiency have helped the company raise its bottom line, Honeywell may be exhausting its ability to extract more profits from its existing revenues. This could result in a slow rate of forward earnings growth and limit the upside for HON share price.

As evident from its most recent earnings report even strong double-digit growth in high-tech segments doesn’t necessarily translate to significant overall sales growth due to Honeywell’s size.

Overall, Honeywell appears to be priced more or less fairly at its current level. Even though the company is performing well and will likely see slow, steady growth for the foreseeable future, its current pricing may not leave value investors with a sufficient margin of safety.

The stock could, however, be a solid choice for fairly conservative investors and those looking for relatively safe dividend growth investments. This view may be supported by the strong institutional buying that has taken place in Honeywell shares over the last 12 months as institutional inflows have totaled over $350 billion compared to just $7.68 billion in outflows.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.