Honeywell International Inc. (HON) Earnings Call Transcript & Summary

So good morning, everyone, and thanks for tuning in to day 2 of Deutsche Bank's Global Industrials & Materials Summit. Hope everyone's staying safe and healthy. For anyone that doesn't know me, I'm Nicole DeBlase, and I'm the lead analyst covering the electrical equipment and multi-industry space at DB. Today, I'm joined by Dr. Rajeev Gautam, who serves as President and CEO of Honeywell's PMT business. Very happy to have him here with us today. Prior to leading PMT, Rajeev held the roles of President of UOP and VP and Chief Technology Officer of PMT, and he's held key roles within UOP for 30 years. I believe Rajeev has a few opening remarks, which refer to a presentation that's been posted to Honeywell's Investor Relations website. After that, we'll dive into the fireside chat. If any investors in the audience have questions, please do submit them via the box on the webcast screen or you can also e-mail me directly. And with that, I'll go ahead and turn it over to Rajeev.

Thank you, Nicole, and good morning. Thank you for having me here today. One of the strengths of the Performance Materials and Technologies business is the depth and breadth of our offerings across multiple industries. So if you can go to Page 2 of the presentation, which is the first slide. As you can see from the business breakdown, the PMT portfolio is well diversified across end markets and regions. Oil and gas business, which means upstream, midstream and downstream refining, constitutes only about 1/3 of our business. This diversity is enabling us to manage through the current challenging macroeconomic environment. While, of course, we have seen headwinds due to the low oil price environment, we also have continued to see strength throughout our portfolio. For example, we are continuing to see demand from our Smart Energy Solutions in the utilities sector. And we have seen strong demand in our specialty products sector, including our health care -- Aclar health care packaging line and our Spectra fiber that is armor line. Good business and growth over there. And one of the continued benefits, of course, of the PMT business is our large installed base across the portfolio. So we monetize the installed base through our outcome-based software and services with recurring revenue. And this has held up pretty well through the crisis. Some hit from the slight contraction in OpEx, but by and large, it's held up very well. And we continue to be well positioned and aligned with the megatrends. So we are actively investing in growth verticals, including connected software; renewable technologies; sustainable solutions; growing into the hybrid market for our automation business in HPS; and expanding the Solstice exposure into residential, industrial refrigeration and e-cooling. We'll continue to focus on driving growth throughout our portfolio, while we aggressively manage the cost base through this downturn and then on to recovery. If you go to Page 2, now I'll touch a bit more upon these 3 growth verticals that I mentioned that we are accelerating, that are tied to macroeconomic trends. Our Connected Software continues to be an exciting area of growth. Current estimates indicate that this year, about 50% of industrial assets will be connected. We are focusing heavily on leveraging connectivity, analytics, and AI to significantly improve asset performance through predictive maintenance and reducing unplanned downtime for our customers. And we are also seeing increased interest from customers in end-to-end remote solutions and services to ensure business continuity, particularly in this COVID and post-COVID manufacturing environment. We also have a strong opportunity in sustainability in terms of renewables and overall sustainable technologies. Some are commercialized, such as our Ecofining renewable fuels technology, and renewable and distributed assets project integration business in HPS. We also continue to invest in expanding our Solstice portfolio with expansion into residential, industrial refrigeration, electronic schooling, thermoplastics and personal care. And the emerging businesses are longer-term investments. Honeywell is commercializing, for example, an energy storage battery, which stores power for longer periods of time, more than the typical 2 hours shift and are safer than the products that exist today to support intermittent sources like wind and solar. We are also investing in the development of advanced plastics recycling technologies that make it possible to recycle plastics directly into new petrochemicals. These are exciting growth areas for PMT, and we'll continue to accelerate our commercial traction and commercialization of these technologies. And I'm pleased to discuss the business with you, Nicole, and everyone this morning. Thank you.

Thanks, Rajeev. That was a helpful preamble. I guess, maybe let's start with the impact of COVID-19. It's obviously top of mind. Which parts of PMT would you expect to be the most impacted by COVID-19? And maybe to that same point, what parts of PMT would you expect to emerge into recovery mode first?

Yes. Good question. Something we have thought about and are acting upon now. There's 2 parts to that question, if I may, is -- one of them is the really strong, if you will, the sharp decline in demand just because of COVID-19 because nothing was moving, nothing was traveling -- moving. And the other part is the price of oil. So both of them have impacted a large portion or part of the portfolio. So clearly, the demand -- lack of demand in transportation fuels, for example, and the price of oil has impacted our refining reload business. Basically, everybody froze and didn't want to spend their cash and postponed reloads into the second half of the year. So that has been impacted. On the project side of the business, if you think of a total project cycle with engineering and licensing, technology and engineering upfront, where the small amount of money is being spent as a projects business, and then you think of the -- that part of the EPC cycle where the steel is on the ground and large amount of billions of dollars being spent. So that part of the cycle, that big billions of dollars spent, those projects, by and large, are moving forward. There's too much invested in there. I mean there may be 1 or 2 pushouts that we see, but only by 1 quarter or 2 while they rebid to get advantage of lower prices, but that's about it. By and large, this thing is staying intact. The early-phase projects are seeing impact in pushouts because it's relatively easy to push out. There's not this like, engineering and feed-type work. So this is something people are going to say, "Well, I'll just wait another quarter or 2 to find out what's going on then I'll invest." So that's what's happening in that sector. In our automotive sector, which is impacted, floating products fell into that. And then the housing is impacted, and metals is impacted as a result of auto, so our thermal solutions business is impacted by that because they smelt burners and -- burner solutions into the industry. But those are the parts that are impacted. And like I said in my opening remarks, things like utilities, Smart Energy, and our Advanced Materials, chemicals businesses, they are pretty much, at this point, not been very impacted.

Okay.

And when we come out of this -- I think another part of the question was when we come out of this, and we are already seeing this, as auto comes back, we have forecasted that auto would come out -- like a lot of other people, that they would come out in the beginning of May. I think that got delayed by 2 weeks or so, but we see the recovery going back. We see the demand in thermal solutions coming back. And the refining reloads, I think will wait, I think, probably the fall before that comes back. So that's where we are in terms of our recovery.

Okay. Got it. That makes sense. And maybe just to follow up on one of the points you made around just a handful, I guess, of project pushouts. Does that mean, Rajeev, that you haven't seen any real project cancellations so far? It's just been a few delays?

We have seen no cancellations. Just as I recall sitting here, 2 delays.

Okay. Got it. That's good to hear. And then similar point, I guess, on the 1Q earnings call, management noted that there have been areas of the business broadly that have seen supply chain disruptions. Can you elaborate on this a bit? And into May, as the economies are reopening, have you seen this improve?

Yes. Well, we did. No question about it. I think we didn't see that until March and even early April because -- well, China was shut down in January and February, but the impact of that began to show up in March, in the supply chains everywhere. And so we began to see slowdown. April was pretty bad. So we saw slowdowns in our factories in China, our factories in Southeast Asia, U.S., Europe. You saw that pretty much all over the place. But we were able to operate because most of our businesses were deemed essential businesses through all of that. So we continued to operate with those challenges, of course, which were hitting us. And we tried to then work with the various governments to get our supply chain back in action. And in some cases, we were successful; in other cases, we were not so successful. But as we go here, I think in March, but going into May, we began to see the supply chain shaping up very nicely. And at this point, there is no supply chain disruptions that I'm aware of that we are hurting from. We pretty much recovered all of that in May.

Okay. Got it. Very good to hear. And I think as per the 1Q earnings call, the expectation is that PMT sales are down in the 15%-plus zone year-on-year in the second quarter. And that was actually one of the better outcomes for the overall Honeywell portfolio. I guess what's the risk that the recovery could take much longer than the other segments, given oil price declines as well as just the general longer-cycle nature of this business?

Yes. So it's a good question. Again, one of the questions, as I said in my opening remarks, we really pay a lot of attention to, worry about a lot. 1/3 of our portfolio, as I said, is oil and gas. So I'll -- let me address that in the second part. I think the first part, the shorter-cycle businesses are recovering pretty well. So as I said, those businesses seem to be coming back. Autos are coming back, which means metals are coming back, and thermal solutions are coming back. So I think that part is good. We saw a little bit of impact on our MRO business, but that's recovering very nicely, too. So all the short-cycle businesses are, by and large, coming back. All right? And then the next piece of recovery is probably the catalyst reloads. But then after that, when will the new projects start? Not the projects that are already in flight, the big ones, as I've said, when will they start? And that's what we are looking at. And we are planning that it will be probably next year. And why do I say that? Because one thing is to have the price of oil so low that nobody wants to spend any money or can't spend any money. That's one thing. We have gone through this period already. But if you look to the future, what will determine the spend will be not so much the price of oil. Even if it's $55, $65 or $75 or $45, so long it gets there and stays there and people get confidence that this is not going to fluctuate wildly, that's when they will start moving the projects along. So we are planning pretty conservatively, saying that, okay, the price of oil may be $40 at the end of the third quarter, maybe $45 at the end of the year and maybe get to $45 to $50 by the middle of next year. So we are planning accordingly and aligning. So maybe that's conservative. But at this point, I think that's probably best to do so to make sure that we align our cost base with our revenues appropriately.

Okay. That makes sense. And I guess maybe taking that a step further. It sounds to me -- reading between the lines of how you've described each of your businesses and where you're starting to see signs of recovery versus where it could take a little bit longer for -- from a longer-cycle project perspective, it seems to me that there is the potential for PMT to return to year-on-year growth as early as 2021. Would you agree with that sentiment?

I won't do any forecasting here, Nicole. That's a little bit of a challenge. All I can tell you is we are planning very conservatively. We are looking at '20, but we are also looking at '21. So anything we are -- actions we are taking now, we look at the full run rate impact of that in 2021, to make sure that if we are -- that if we end up being flat growth or slight small growth, that we still continue to increase the bottom line. But beyond that, it's kind of difficult for me to forecast. It's very uncertain for us.

Okay. Fair enough. I had to try. So I guess maybe understanding oil and gas is only 32% of PMT segment sales, I think that's probably a bit lower than investor perception. How do you think about managing this business through a low oil price environment? And I mean, you've been within the PMT segment for a long time, albeit spent a lot of time at UOP. So maybe drawing on what you've learned over the past downturns, how do you approach that as a manager?

Yes. I think the -- in the short term, the first thing we did was just drastically shift our resources to where the business was. I mean there was places, there was business; and then places there wasn't business. So -- and then we had the new verticals that we have been growing. And they're not small, and they were still growing, and they're almost over $1 billion now. So we shifted resources there. So that was the first quick thing. And second thing, of course, is aligning our cost as fast as we can. We moved that. We jumped on it right away and aligned them correctly and properly. Because I knew that as soon as things began to freeze up, the inventory would start piling up and the supply chains will be disrupted. So we started aligning our cost base right away as soon as we could. And then we have -- as we look forward here, we think that -- and in fact, what has happened is the renewable business, for example, global diesel, jet fuel business has really taken off. It's surprising almost a lot of refiners, even the U.S., want this now, Latin America, even the Middle East, Southeast Asia. So those parts of the business are helping us get through this or focusing on the areas where we still have business and growth, controlling our costs and the rest of the place and then carefully monitoring our volumes and our cost in our plans to make sure that they are always aligned because we could lose the game right there if we are not careful. So those are some of the actions we've been taking in this crisis environment that we are in. And then we've been putting out solutions that can help our customers through the COVID-19 crisis. So there are several of them we've put out. One of the ones that I thought we acted very quickly was, in March, we rolled out a solution for remote operations and services, for example. And we stood that up in our own plan in Orange. Just -- first, just to provide social distancing. But then we knew that people would start limiting the number of people who could be at site, in the control rooms. And how do you do -- run your operations without engineers on site, how do you protect your operators and engineers? So we created remote operation centers, virtual maintenance. In fact, we used our remote technology to commission projects during the crisis with our engineers located in Houston and Bangalore. And for example, in this case, the project was in Thailand. And that project was successfully commissioned. So there's a great deal of traction on that now from our customers. So we've been looking at things that we can bring out and help our customers during this time of crisis, looking at areas where we have growth and controlling our costs.

Okay. Got it. That makes a lot of sense. And I mean, I think investors completely understand or mostly understand the impact of low oil prices on the HPS business. But where I get more questions is around UOP and to the extent the different pieces of UOP that are impacted by lower crude prices and the pieces of UOP than aren't. Could you maybe elaborate on that?

Yes. Sure. Sure. In UOP, the piece that has the biggest impact is the midstream gas business and the shale oil space. So that was really already slowed down last year, and we had started to take action on that business last year. But this year -- towards the end of the year, we booked nothing in the shale gas space, cryogenic plants, as we call them, cryos. And then this year, nothing so far. So this thing is pretty much dead and will probably continue to be dead. Permian may continue -- as parts of Permian may continue -- will continue, I'm sure, because they can probably operate in a $40, $45 oil environment. But outside of that is going to be a little bit of a challenge. And then as I said, we have the projects business, and there are 2 parts to it. Now I'll refer them to the licensing engineering piece, which is the upfront piece and then equipment piece. In equipment, the back end, which is tied to the big projects like HBS is, those projects are moving forward. The backlog actually there has increased. Because those projects are moving forward, people are placing orders or have placed orders. And so that part of the business is oversubscribed. So far, the backlog in licensing engineering is very good. It's -- basically, we are -- even in the fourth quarter, we are 70% to 80% sold-out already in that area. And the backlog there is still holding strong. Going forward now, that's the part of the business that will be impacted and will recover probably more like -- I think some people call it a Nike recovery, if you will, over the next 2 quarters and maybe into the first part of next year.

Okay. That's really helpful to characterize. Maybe shifting to LNG. Can you just maybe talk through exposure to LNG within the PMT segment and your level of concern around project pushouts and cancellations here? Or is this an area where you think that the backlog seems more intact, more solid?

Yes. We actually don't have that much exposure to LNG. We have some. I mean the total exposure is roughly less than $300 million. And those projects are still all moving forward. But no question that as you go forward and look at it, LNG space has slowed down. And any new projects there will take a little bit longer to materialize maybe as people begin to rationalize and that -- look, it will depend upon how fast demand comes back and what the price of gas traded over in Asia, going to China, go to Europe materializes that. So that will depend upon how strong LNG is. I think there are going to be some projects still go forward, but never -- but not the number that I think are out there in terms of either seeking work approval or with work approval.

Okay. Understood. Got it. That's helpful. And then maybe shifting over to Advanced Materials. I know at last year's Investor Day, you noted that the total addressable market for Solstice is expected to expand by $7 billion. Can you give us an update on where the total addressable market sits today? And I guess regarding the expectation for a 15% market CAGR on the slides and on the same Investor Day, do you still think that, that's doable?

Yes. So just for reference, the current TAM for Solstice is $19 billion. And this is -- the current TAM is in markets like autos, OEMs, foam, commercial refrigeration, chillers, et cetera. And we expect this TAM for Solstice to expand by another $8 billion, driven by growth in the auto aftermarket; nonregulated vehicles; U.S. residential and [ BRS ] ; industrial refrigeration; electronics cooling; thermoplastics, which is an area of foam and blowing agents give really good properties; and personal care; and pharma. So these are areas where we should continue to see growth. And we expect to achieve Solstice sales with a 10% to 15% CAGR over the [ strat ] horizon.

Okay. Got it. And has that business at all, the trajectory maybe, been impacted by weaker auto sales in recent quarters? Or has this been an area of strength?

Oh, no, no, no. This -- no question. It was impacted by autos, for sure. They slowed down, as I said, completely in March. And -- sorry, late March; early April, complete slowdown; and then a recovery in May. So we were definitely impacted, and our demand in that area dropped significantly. No question. But as I said, the autos are recovering. Will -- how fast will -- they're recovering actually quite nicely and sharply. The question really is, in all of this, which I don't know, and that's why we have been conservative in the forecast is, will this get back to the 2019 level and how fast? I'll let people who are better forecasters than me come up with the answer to that. I'll just plan conservatively to say it will be slower than -- we're seeing pretty fast growth, but I -- we are not standing until we're ready.

Yes. It makes sense. That's a million-dollar question. Okay. So maybe shifting to Connected. I know you talked about this as one of the areas where you're making investments. Can you maybe give us a sense of the revenue contribution to PMT today? And how fast this is growing? Or some sense of where this could go in the future?

Yes. This is a really strong area for us. I mean a lot of our customers -- I mean they were already into our Advanced Solutions, but now with the Connected, how easy it is to be connected. This has really taken off. As I said, 50% of our customers will be connected by the end of the year. So our software sales today -- our Connected Software sales today are about roughly, call it, around $400 million roughly, with the total software sales of roughly about $1.3 billion. The difference is our embedded software. So that's the scale of our business, and we certainly have plans and expect to grow this revenue double-digit CAGR over the next 3 years. And while most of our businesses have a software component, a lot of this is in our automation HPS business because they are already connected. So it's a lot easier to use that channel to provide connected solutions, and people -- our customers are used to getting those solutions in those channels. So we have been providing solutions to significantly improve asset performance through predictive maintenance and reducing unplanned downtime for our customers. Good traction on that. And then now as we go forward, remote solutions services seems to be getting a tremendous amount of traction.

Okay. That's really helpful. Thanks, Rajeev. And then maybe shifting to some of the cost savings that Honeywell has guided to. I think for the total company, you were looking at Phase 1 savings of about $1.1 billion to $1.3 billion, with a potential Phase 2 being mostly permanent and the first phase being more short term in nature. Can you give an update on where PMT is in the Phase 1 process?

Yes. I mean we, like all the other businesses, will have our phase-in plans in action. They're finalized, they're moving and have been moving for some time. So that part, both our temporary and permanent cost actions are in place and in flight and in line with the figures that Honeywell has put out and highlighted at the investor call. And as I said, we moved quickly to implement this, to rightsize our cost base. But unfortunately, I just don't know how to predict the price of oil. Well, we do have a prediction, but you know how that goes. So there are people who have theories that the price of oil could recover faster and, in fact, seems to have been showing that. It's recovering quite fast. I think some of that is okay because the demand for jet fuel and diesel and gasoline was so far down that there is a fast recovery when you look at how fast people hit the roads, right? So that is, yes, I can see some of that. But long term, I think our forecasts are still valid. So we're going to still plan very, very conservatively, as I said, as we look at our cost base.

Sure. Definitely makes sense to go that way. And maybe hitting on the investments and opportunities that you brought up in your slide presentation at the beginning, what do you think if you were to look at what's on the slide? What's the most promising or most imminent investment opportunities?

Okay. So the good news is there are several of them that are in flight and making us good revenues, renewables, Ecofining technology. We developed it many years ago. We helped commercialize that. It is a first-of-a-kind technology. We were the people who helped commercialize it in the world. So finally, it's hit and it's gotten really good traction. Solstice, of course, also on the sustainability side, continues to grow. And the Connected Software, as I said, that thing is going very well. And we are developing more products, which are tied to the areas that I described, products like Connected Worker and the Connected Plant areas. So those things are going well. The 2 new areas, which are pretty exciting, are in the areas of renewable power. So this is where we are developing a battery. Now today's batteries, yes, they are commercial, and they are based on lithium ion. They generally shift power for about 2 hours. If you want to go more than that, the cost begins to escalate. And of course, there is an issue about safety that you've got to deal with. We are developing a battery that can shift power 4 to 8 hours, it's not lithium ion. And it will allow a great deal of flexibility at the grid level to a lot of producers of solar and wind. So that, along with battery management systems and EMS systems, is an area that we are investing and investing heavily. The last piece is also very exciting, is in the renewable plastics and -- not renewable plastics, plastics circularity and recycling plastics. We supply a lot of technology into this area, and we have expertise in plastics as well as in refining technologies. We use a lot of that, like we use pyrolysis technology for renewable fuels, we use the FCC type technology for renewable fuels. So we are using all that know-how to develop a process, which is now in commercialization phase, which will convert plastics into a plastic oil, which can then be aptly fed into an ethylene cracker to make ethylene or into a propylene to make propylene. So this is pretty exciting. We are bringing this out in 2 parts. One of them is a smaller 30-ton facility and a 200 ton -- 30 kmta facility and a 200 kmta facility, all modular. We expect the 30 kmta facilities to be closer to the recyclers and the 200 kmta to be closer to the producers of the plastics. So pretty exciting, and we're really moving forward on that.

Now that's a great list, Rajeev, all really exciting stuff. So I know we're running short time here. We probably have time for one more question. I'm just going to -- we spent a lot of time talking about the growth opportunities, top line. When we look at PMT margins, they expanded to 22.5% as of 2019. How do you think about the potential for margins to continue moving higher from here? And is that doable in a lower crude price environment? Or do you think that will be challenging?

No. No. It is very doable. I mean, in fact, the -- as you probably know, on the price of oil and -- well, our margins and our customers' margins are not that driven by the price of oil. It's, of course, the margin between the price and the supply that matters. So some of the refiners are actually making good money. Those who are producing are making good money, and they were, and I think they will again. So -- but that just says that the environment will improve. But for us, our margins, yes, we can grow, no question about it. We have had confidence, one, because of the new verticals that we have made a great deal of traction in. We have been talking about this for some time. And these are all high-margin, high-growth businesses. So we -- as they become a larger part of the portfolio. And we -- as I said, we are already over $1 billion in this area. And so -- and that's 10% of our business, and it will continue to grow in double digits. So you can see that this will impact it. But then, you take our SME business, when we took that business. We've fixed it. We're getting margin expansion in there. Our HTS businesses, and our LSS businesses, as we grow into more enabled services and expanding margins. In our life cycle solutions, the catalyst business, as we go into more outcomes and Connected Services and we're getting good traction on that, we're getting better margins. So this aftermarket and monetizing it as recurring revenue is really giving us another source of margin expansion. So yes, we expect margins to continue to expand over the [ strat ] horizon.

Got it. That's great to hear. Okay. So I think we should go ahead and wrap it up there. I think we're coming up against time. Rajeev, thank you so much for your participation today. This has been a really insightful session. And thanks to everyone in the audience for tuning in.

It's been a pleasure. Thank you.