We're lowering our Honeywell price target after earnings. The risk-reward is still favorable

Published Thu, Apr 25 20242:20 PM EDT

Honeywell shares are under pressure Thursday, despite the industrial conglomerate exceeding expectations for first-quarter sales and earnings. The culprits: Softer guidance for the current quarter and some uncertainty about a recovery in some of its key businesses. Revenue for the three months ended March 31 totaled $9.1 billion, topping Wall Street expectations of $9.03 billion, according to estimates compiled by data provider LSEG. Sales on both a reported and organic basis rose 3% year over year. Adjusted earnings per share of $2.25 advanced roughly 9% compared with the year-ago period, ahead of the $2.17 consensus forecast, and above the high end of management's guidance. Segment margin , similar to an adjusted operating income margin, grew about 20 basis points on an annual basis to 22.2%, slightly below Street expectations but matching the high end of management's previously forecasted range. Honeywell Why we own it: Honeywell is a provider of industrial technology solutions to companies in various industries. We appreciate its exposure to the aerospace industry as a parts supplier. The portfolio has, however, become a bit bloated. We think further upside will come as the company divests non-core businesses and focuses both internal investments and acquisition efforts around management's three targeted mega-trends: automation, the future of aviation, and the energy transition. Competitors: Emerson Electric, RTX, 3M Weight in portfolio: 3.57% Most recent buy: April 10, 2024 Initiated: July 5, 2020 Bottom line We would characterize the results as better than feared, considering the stock was already under pressure going into the print. On top of the better-than-expected sales, earnings, and organic growth results, Honeywell's backlog jumped 6% year over year to a record $32 billion, as long-cycle demand remained strong. Also, management is seeing pockets of recovery in its short-cycle businesses and expects more improvement as the year progresses. As a reminder, long-cycle businesses are less sensitive to near-term economic conditions since there's a long period between when an order is placed and when it's delivered. Aerospace is a good example. Honeywell's building products unit, which includes things like fire-protection systems, is an example of short-cycle business. However, it's hard to get too excited as the second-quarter guide came up short and there was some weakness in key segments, along with a miss on the overall segment profit margin and cash flow results. The stock isn't going to be able to make a sustained move higher until all divisions return to growth. The strong orders are encouraging; we just need to see them get converted to sales. Also encouraging is management's ongoing effort to streamline the portfolio around three key megatrends — automation, aerospace, and energy and sustainability — by divesting about 10% of non-core assets that don't fit these trends. This will free up capital to invest in internal growth initiatives and mergers and acquisitions. We reiterate our 1 rating because the risk-reward ratio is favorable at current prices given the record order book and expectation for things to improve in the back half of 2024. However, we are trimming our price target to $225 from $230 , acknowledging that the next few months may be choppy until we get a precise timing of a recovery in the short-cycle businesses. Guidance Looking at the guidance table above, management's outlook for the current quarter — its fiscal 2024 second quarter — came in below expectations, while the full-year forecast was mixed versus the consensus. The second half of 2024 stands to be stronger than the first half. Note that the full-year forecast remains unchanged from the last forecast alongside the fourth-quarter release. On the post-earnings call with investors, management reiterated that this guidance assumes sustained demand for long-cycle business units and a "modest back-half recovery" in the short-cycle segments. These businesses tend to be more profitable, so a pickup in demand will be a swing factor in future results. Should the economy hold up or improve, we wouldn't be surprised to see management's forecast prove conservative. The team also expects a sequential improvement in the back half of 2024 as conditions improve. As the earnings chart above indicates, Honeywell's segments were a mixed bag. The strength in aerospace technologies and energy and sustainability solutions was partially offset by weakness in industrial automation and building automation. Organic growth was led by aerospace, up 18% year over year. Within the segment, commercial aviation realized its 12th consecutive quarter of double-digit growth as original equipment sales advanced over 20% versus the year-ago period, aftermarket sales increased 17% organically, and the defense and space segment was up 16% organically as the supply chain continues to improve. In industrial automation, process solutions were unchanged organically year over year, while warehouse and workflow solution sales plummeted 55% as a result of lower volumes. Sensing and safety technology was down 8%. Productivity solutions and services sales were down 11% organically, though management said orders are growing sequentially and year over year for the second consecutive quarter, "a positive sign that we are nearing a return to growth in that business." Building automation was down year over year as growth in the longer-cycle solutions business was offset by continued weakness in the shorter-cycle products business. However, on the call management said that building automation orders improved on a sequential basis, resulting in a book-to-bill of 1.1. A book-to-bill ratio measures the amount of business booked versus the amount billed. The higher the ratio, the better because it means that demand is exceeding supply and resulting in backlog growth. Honeywell's energy and sustainability solutions benefited from a 6% organic increase in advanced materials sales and 3% organic increase in UOP, its petrochemicals business. (Jim Cramer's Charitable Trust is long HON. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Honeywell International Inc. signage is displayed on a monitor on the floor of the New York Stock Exchange (NYSE) in New York.

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