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

Okay. Okay, great. So good afternoon, and thank you for joining us today. My name is Peter Arment. I'm the senior aerospace defense analyst at Baird. We're very pleased to have with us the management team of Honeywell International. This is a fireside chat so we'd encourage anyone to ask questions via the web portal. And if there's time at the end, I'll certainly try to squeeze those in. And from Honeywell, we have Greg Lewis, who is the Chief Financial Officer and Senior Vice President. And Greg, thank you very much for joining us today and appreciate your time. And I'll pass over to you to maybe make some opening comments and then we can get into the Q&A. Thanks.

Well, again, Peter, I just want to say thank you for having me today. It's a real pleasure to be here with you. I'm just going to go through a few quick slides very briefly, some of which you've seen from our recent earnings release. So Peter, Slide 1 really is just a quick summary of where we are. This business, this company is in a terrific position. And we've done a lot of work around our portfolio. I think you've seen that through spins, some small divestitures, bringing on new assets with things like Sparta and Performix to get into both our software businesses as well into some other aspects of things like life sciences. You know that our execution is a hallmark of what Honeywell does. You saw our ability to execute in all environments as we went through the COVID downturn, and now we're working through the recovery that we have. Our end markets are as strong as they've been in the 15 years I've been here at Honeywell. We've got tailwinds in aerospace, in energy, in warehouse automation, buildings, infrastructure. You name it, across all 4 of the main business groups as well as digitization with connected enterprise. So end markets are great. Now as we talked about on the earnings call, in the very short term, this inflationary environment is a challenge. We're facing headwinds on material shortages and things like logistics, inflation and freight. And we're battling through those, but they are tamping down our growth potential here in the very short term. But ultimately, when you think about Honeywell, one of the things that I hope investors appreciate is our innovation, whether it's innovating in the core, as we've been known to do for many, many years, or in our breakthrough technologies when you think about things like Solstice, things like Quantum. We're constantly thinking about not just in the short term, but we're really managing for the long term in order to create this position that we have. So we feel very strongly about what's to come, what's in front of us for the next 2 to 3 years specifically. And I think we've positioned ourselves very well to take advantage of both the near-term tailwinds as well as some of the macroeconomic long-term trends. So if you flip to the second page, again, I'm not going to go over this a lot of depth. This is what we talked about in our earnings and it just underpins what I just shared earlier. As we head into 2022, the backdrop is very strong, both from a top line perspective as well as margin expansion. We're going to have a nice recovery in our aero aftermarket. We talked about the strength that we're seeing in our UOP business, which is going to drive high-margin catalyst shipments, improved execution in warehouse and workflow solutions will help us. But we will have some margin headwinds due to both the investments we're doing in Quantum as well as things like the inflation environment that we're tackling. But ultimately, we're going to be a strong capital deployer, both internally through our R&D profile, our CapEx profile as well as our M&A profile. So we've got $12.5 billion on the balance sheet, and we have preserved that fortress balance sheet to be able to give us all the flexibility that we do need to allocate capital in the future. And if you go to the next slide, this is one I'm pretty proud of. These are really just a selection of some of the most recent announcements that we made. We highlighted a few of these in the earnings call. I think they get lost at times when they're just coming out in an individual press release. But the point is our sustainability story is one of the hallmarks of Honeywell. This is really around renewable fuels, the hydrogen economy. There is going to be an energy transition. We're going to participate in that in a very big way. You should think about UOP as a sustainable solution provider for everything that's going to happen in the energy transition. Plastics recycling a big deal for us. So you should -- I mean you come to see these things each and every quarter, we continue to do -- Dave used to call it seed planting, but we've continued to make these investments in our technologies, creating innovations that are going to enable that sustainable future. And ESG being such a big part of the investing story, I think Honeywell has an underappreciated stature as it relates to ESG, and we're going to continue to do that. Over 50% of our R&D, as you know, we've talked about it before, goes to sustainable solutions. And this is just a small selection of those real proof points that while may not move the needle tomorrow, these are things that we are investing in to maintain and ensure the long-term growth trajectory for this company. So if you go to the last page, just briefly, this is our guidance. The message here is we talked about it in our earnings release back in a few weeks ago. And the message here today is it's as challenging as we thought it was going to be. We talked about having a wider range both for earnings and for sales. You saw we came in, in the middle of the range on revenues, down maybe towards the lower end of Q3, and we took our sales guidance down. This is going to be a tough quarter. And so you shouldn't be expecting that everything is going to go green lights through town or everything is going to be on the top of the range here. We are doing all the things that you would expect us to do from an execution standpoint, pricing, inflation mitigation, supply chain mitigation. But there are still headwinds in front of us in terms of the holiday season, what will happen to logistics. The port situation has not cured itself. So it's going to be a battle all the way through the quarter. So we're reaffirming our guidance, and I will say again, our guidance range, and we will update you as necessary. But things are turning out to be as challenging as we expected when we closed the quarter. So with that, I'll turn it over to you, Peter. I'm looking forward to the -- looking forward to the Q&A. So thank you again for having us here today. Really happy to be with you.

Terrific. Thanks so much, Greg. And we certainly appreciate the rundown there. So maybe if you could just -- to kick things off and particularly talking about getting your latest thoughts on inflation, the supply chain constraints. I know Darius made a point on the call to call this out as a near-term headwind. Maybe you can walk through the impact on each of the segments. As you close out the year, you look at the first half of 2022, can Honeywell kind of outperform the sustained inflationary environment?

Yes. So I think what I would say is the following. I mean, we've got the execution rigor in the areas that we need to pay attention to, whether that's pricing in a very dynamic way. By dynamic, in some cases, I mean, weekly. We're getting ahead of that as these things evolve very quickly. We're not going to sleep on inflation. But when you look through the businesses, as I talked about in the earnings call, the ramp up of the aerospace supply chain complex is going to be one of the biggest variables in terms of the trajectory of growth there in the fourth quarter and into '22. So we're doing what we can to reach back into our supply base and try to help our suppliers actually ramp up themselves as well. I mean some of it comes from giving them deeper visibility into the demand that we're seeing. Some of it comes through making longer-term commitments for parts and so forth. Some of it actually goes into literally trying to help them in terms of acquiring labor where we can because we've got some sources of labor that can be leveraged. So I think aerospace, pretty broad supply chain challenge overall. It's knocked down to a few different parts. When you go into HPT and SPS, now you're getting into things where it's really -- it's very much geared around electronics. There are some other things that are challenges, too. We talked about certain resins and so forth, but it really is about the electronic storages. We're working with the suppliers that we have. We talked about it in the earnings call. We've done a lot of work in both HBT and in SPS on doing reengineering to create opportunities to use different chipsets in some of our designs. And those things are actually going live here right as we speak throughout the quarter. PMT has some of those issues, but it's far less than the other 3. So I guess as we think about the fourth quarter, our range, as I mentioned earlier, really contemplated some of these challenges, and they are real and on an everyday basis. What the -- it's hard to say whether we've -- I think the fourth quarter may be the peak of that, certainly in HBT and SPS. It's really too early to call what's going to happen as far as the supply chain in Aerospace more broadly. So we do see that the first half is probably going to be a little bit more challenged than the second half. But we have a lot of confidence that we're going to have a very nice growth story overall into 2022 in the portfolio.

Terrific. Well, let's talk about defense, I guess, just because most of the defense companies this quarter, it was a little bit more dynamic than usual. Maybe you can provide a little additional color what you see across your Defense & Space portfolio as we look out over the next couple of years?

Sure. Well, I mean certainly, the defense budgets are down into the 0 to low single digits. I think the defense budget is up in the U.S. maybe about 2% in '22. I don't really see that changing dramatically and they are going into a bit more of a modernization program, whereas in the international side, the platforms there, the more legacy platforms, I think you're going to see a lot of continued robust demand in the legacy platforms on the international side. I don't think that we're going to see further or dramatic deceleration from here. I think we took the majority of the pain in our business this year. And we've talked about it. The third quarter, as we discussed, was down 17%. That was definitely influenced substantially by the supply chain. I think we talked about it being down low single digits, excluding the supply chain challenges. But we see low to mid-single-digit growth as we go into 2022 and beyond. We are taking some of our capabilities and technologies to our customer base. You can think about their demand. When you think about modernization, you can think about things like connected becoming more relevant and important. So we're taking some of our connected solutions to them as well. So it's definitely going to be a slower growth environment than we saw in '18, '19 and into '20 when we were talking about high single digits, double digits kind of growth. But we do see a slower growth environment, but growth as we go out beyond '21.

Perfect. And then on the commercial side, there's obviously -- we've started to see a commercial aero recovery. Things are slightly maybe different than domestic and international. International, obviously, still waiting for those tailwinds to kind of maybe kick in a little bit. I'd be curious to your thoughts if you're seeing any differences there? And then also, just I'll just weave into the question just regarding aftermarket because we know it's a big part of kind of one of the bigger drivers going forward.

Yes. Well, on the OE side, demand is increasing fairly robustly. I think you see the same data that I do around Boeing and the MAX. I mean they're dramatically increasing their deliveries. That's certainly going to drive outsized growth in an ROE business. The BGA recovery that's happened, and I think you know this like our aftermarket business in BGA is already at or above 2019 levels. So you just translate that into demand for new equipment. And by the way, the lease market, there is virtually nothing on the lease market. So the demand for new equipment has gone up dramatically as well. So I'm anticipating and we're seeing our OE deliveries demand go up quite substantially for 2022. So that's going to be fairly robust as well. And then as you mentioned, I think the BGA aftermarket is going to continue to grow. I think people who have gone to business jet travel, a lot of that has been -- some business travelers, some leisure travelers. I don't really see that reverting back to the mean. I think people who have made that meet will stick with it. So I think you're going to see nice growth in the BGA side in 2022 and beyond as well. And as you highlighted, it's just November 8 that the international travel restrictions into the U.S. have been lifted. So it's literally like now that I would expect despite seeing some of the international demand start to peak back. I don't know about you. I think we talked about a little bit earlier. You're getting out traveling. We are, too. So I expect a heavy business travel demand next year. People want to get out and see their customers. They want to get out and see their employees, their own operations. I think this work-from-home circumstances has not been great for business, and people want to get out and go do those things. I know it's -- listen, it's an advantage to be across from your customers when you're trying to get the [ equation ] on. So while this kind of interaction is convenient and it may be efficient, it's not our optimal way to operate. So I expect very robust aftermarket. Now what I will tell you is there's going to be, just like in the downturn with the pandemic, it's hard to predict behavioral shifts from some of the airlines. I expect there's going to be some surprises in there with the way maybe maintenance is performed. Will they go -- will they run equipment hotter and a little bit longer to maximize their outcomes in 2022 because they've been starved for the last year or 2? So there may be some surprises in there for us in the way in which the actual airlines behave. But the demand should be very strong, and I expect a healthy recovery in '22 and '23 of ATR, in particular. And as I said, BGA were already recovered.

That's a -- it's yes. We agree, obviously, the tailwinds are there. Okay. So let's talk about ESG because you brought it up on the slide. So ESG and the sustainability, they're having a much, much bigger impact on how portfolio managers manage their portfolios. Maybe talk about how -- about Honeywell's sources of differentiation. How do you -- from an ESG perspective when you look out there?

Sure. Yes. So glad to talk about that. I mean if you think about UOP, I mean, you should think about UOP as the sustainability company. Yes, we're going to enjoy the recovery in the traditional carbon economy, and we bring all of the technologies that are underpinned, both the petrochemical and the oil and gas infrastructure, but we're also going to be the partner of choice when it comes to those energy companies making that transition. Are they going to trust making those changes to new partners? No, I mean we've got deep and long-standing relationships with many of those people. And that's going to happen over time, right? That -- one thing we can all agree on is while we're heading towards a sustainable energy economy, it is not going to happen quickly. And so we are going to have a carbon economy for some period of time. And our UOP technologies underpin many of the things that aren't going to have to happen, whether it is plastics recycling. I mean we were one of the inventors of green jet fuel. It was 20 years ago, the demand wasn't there necessarily for it, but it's going to be there now. And so that's where when you think about sustainable aviation fuel. I mean, we are -- you saw in our announcement with Alder. We're partnering with people in the industry. We've got United as -- the partner was agreed upon, the offtake of that fuel. We've got the partnerships. We've got the technology. We are going to be there to be in the forefront of this energy transition. So from an energy standpoint, we're a big player. When you think about Solstice in the PMT business at AM, I mean we are what is creating lower global warming solutions. You know that we're working on that with the stationary opportunities. And as those things become more prevalent in the oncoming future, our Solstice business is going to have another growth trajectory in that regard. We've talked about that 2025 and so forth. But it's those molecules that we bring to the market to create some of those solutions. When you think about healthy buildings, who is not going to want pure air quality when they come back to work? As I said earlier, we want to be back to the office. Many others do, too. But you want to be there safely. We do too, right? So who's going to bring those solutions to you from the standpoint of not only being able to deliver the devices that bring strong and good air quality, but also the connected solutions that are going to let you know when you walk in the room. What does it look like? I mean that's what our connected buildings and our healthy solutions bring to the floor. And then don't forget, a lot of ESG is about safety, worker safety. All of the solutions that we have in terms of worker safety and SPS. So I mean, you go through our entire portfolio and everywhere you look, again, whether it's aviation fuel, whether it's low global warming, whether it's worker safety, whether it's building safety, our whole portfolio just screams of ESG. And that's just from the sustainability of the environmental. And then from a governance standpoint, I will put our track record up against any. I don't know if you've read our sustainability report, our diversity and inclusion statistics. We're not perfect, but we're always making progress. And our progress actually is out of love and ahead of our peers. From a governance perspective, we've been very proud of the makeup of our Board. It's one of the most diverse Boards that you will see in a space like ours. So this is not something -- this is not something that we just started doing 2 years ago because [ we think it became a fad ]. I mean, we've been doing this for 15 years. All of the investments that we've made in recovering, in renewing on many of the legacy challenges at some of the sites that were with our legacy manufacturing facilities for many, many years ago. The Dave Cote management team and now Darius, we have taken care of those things. And there's many success stories of renewing those locations and putting them back into sustainable and very productive use for those communities that we've worked in. And then I guess, lastly, on the community side, everything we did for COVID, whether it was the mass production we've put in place to bring that to bear for the communities in which we work and live in, whether it was some of the things that we did bring oxygen into our India population. The mass vaccination, we vaccinated 150,000 people in the Charlotte area in partnership with the Tepper organization and with Atrium Health. That -- those are just feel-good things that we do because that's the way we work and live. That's part of our culture at Honeywell. It's not a fad. We live and breathe that every day.

Yes. No. It's -- you guys have been a leader. I think 20 years ago, I was at that air show when you introduced that green fuel. So it's been something you've been talking about sustainability for a long time. So it's just not lip service by any means. Maybe Greg, a little -- in our remaining kind of minutes, let's switch over to warehouse automation growth. That idea continues to be stellar. It sounds like the path for Intelligrated continues to be a much bigger business. Anything to call out for investors as we think about this growth and the time line of reach and scale?

Sure. Yes. I mean, as you know, I mean, we've talked about it a number of times. When we bought the business, it was $800 million. This year, it's going to be a little bit over $3 billion. We're going to experience something like 65% growth in 2022. Now we are not going to be growing at that hyper rate every single year. But again, I'd ask you to find how many technology companies put up those types of growth numbers. But the good news is we're going to continue to see strong growth. I mean, you know it. I know it. We're all going to more of e-commerce buying strategy in the way we live and the way we work. That's not stopping anytime soon. So the demand profile here is very strong going forward. So we expect to see very strong growth overall. And more importantly, the pivot towards the services and software aspect, because that was the whole plot where it was get a strong position, create a big installed base, and they create recurring revenue models and a much, much richer profit pool on the service and software business that's coming behind it. And we're seeing that. Even that business, our LSS business this year inside of Intelligrated has grown greater than 20%, which is great news for us as we build this installed base. So I think we're going to see very healthy growth in Intelligrated for a number of years to come. $3 billion is just the beginning. From $800 million to $3 billion, you could -- you can do the math on the forward projection. But this is going to be a very sizable and profitable business for us in the portfolio as we project forward.

Yes. And then you've talked about transitioning or becoming a software industrial company. Maybe you could remind investors maybe how big of software is today and how fast it's growing? And how differentiated against your peers? I know you have literally thousands of software engineers. So maybe that's a good way to kind of talk about that.

Yes. Roughly half of our engineering population today are software engineers. And so that is an enormous strength for us as a company. And what I would tell you, our software business today, it's over $3 billion, a little over $1 billion and change of that is the connected enterprise. The remainder of that is in our embedded software offerings. The connected business has been growing greater than double digits strong since Que has taken this business over and really created it in 2018. So we've seen some very nice growth rates there. And again, importantly, what she's doing is she's shifting the portfolio into much, much more of a SaaS and recurring offering type of a business. And that recurring business has been growing at 20% plus. So the overall software business that she's got had been growing double digits on a recurring business greater than 20% kind of a clip, which, as you can guess, is just creating accretive margins. And by the way, that's -- the best part about this -- the double-whammy positive here is you get an increasing growth trajectory, which helps our top line growth, and it's also a part of our margin expansion story, which is one of the reasons why we feel like our margin expansion runway continues to be very robust. People ask us all the time, like is it over? Back when you started, you had 13% margins. This year, you can be back to something around the 21% range. When does it end? We still feel like we've got a lot of runway, whether it's the connected enterprise, what we're doing with digital, the supply chain transformation. We have a lot of gas to take as we think about our growth trajectory. And then again, we talked about it before, our diligence around commercial power of one and fixed cost power of one just creates an enormous amount of leverage. So very, very confident in our ability not just to continue to really take advantage of the software growth that Que is building, but also the overall growth of the portfolio as we pivot it to very attractive end markets. Again, we talk about life sciences in the beginning just as an example. And that doesn't even contemplate bringing the capital allocation lever into the plan.

Yes. No, and it's allowed you to -- you're generating a lot of cash and budget to invest in a lot of different breakthrough initiatives. Maybe just to wrap up at the end just because we only have about 1.5 minutes left. Just talking about capital deployment, M&A, things that areas in the portfolio are looking at and seeing, and just give us a general idea as we go into 2022.

Sure. Well, as you saw, I mean, we went out and actually refinanced some of our debt that was coming due. We initially were going to repay that. We actually brought a bit more debt back on the balance sheet so that we would have the capacity to continue with a strong M&A pipeline. Our bias is towards M&A. That's still true. We have our 1% minimum share reduction target, and we'll have that for 2022 as well. We're probably going to do something like 1.5% here in '21, given where we are through 3 quarters. But we're open for business to M&A across all 4 segments of the portfolio and connected. So what we won't do is just pivot all towards software. We want to have a nice mix between software and more traditional acquisitions that will give us some more immediate cash and earnings uplift. If you piled all of your M&A dollars at the software, that kind of puts off the payback on that a further time horizon out there. So we want to make sure we get the nice balance around that. But you've seen what we've done in life sciences. We love the life sciences market as an example. Number one, it's got a great growth trajectory. Number two, it's got a very sticky growth profile or sales profile given the regulatory environment around things like life sciences. So those give you some sense of the kinds of characteristics that we'll be looking for. But we'll always want to make sure that the things that we're putting M&A dollars around have strong technologies or things that we think are going to be better owned by Honeywell, and again, are going to create a stronger growth profile on the top line and a better margin profile from an earnings and cash perspective.

That's terrific. Well, that's a great way to recap it. Greg, thanks so much for joining us. I mean, you've got a lot of momentum both just in terms of not only heading into '22 from -- both from a lot of recovery from what we've experienced from COVID, but also the margin expansion, generating a lot of cash. And I'm glad we were able to talk about the sustainability piece because it doesn't get enough attention. There's obviously a ton going on there. But thanks again for supporting the conference. Hopefully, we'll get to do this in person next year, and we look forward to that. Thanks again, Greg.

All right. Thank you very much, Peter. Appreciate the time.

Take care.