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

[Audio Gap] Last time we were live was 3 years ago in 2019, so it's a long time. So it's great to be back live from New York. Before we kick off with Honeywell, I think it's fair to say we're very thankful to the conference team for putting together this conference. It's a gigantic pain. I was going to say something special there, but we're being webcast so better keep it clean. Very, very difficult to get these things together. Secondly, thanks to Nomura for providing us with great facilities. And finally, a big thank you to the corporates because that's the reason why we're all here. So thanks, Greg, for being here. And with that segue, why don't we kick off into remarks. Greg Lewis, CFO of Honeywell, very pleased to have you here. A couple of remarks then we'll go to Q&A.

Thank you. Yes. So I have just a couple of quick slides. You guys have seen our release. I mean as we headed into this year, obviously, a lot of uncontrollables going on in the environment. But for the things that we are in control of, we feel pretty good. As highlighted here, our end markets are very strong. We feel very good about the energy transition. We're going to have a big play in that as it progresses forward from here. Sustainability, a big part of our portfolio and also a big macro trend for us to take advantage of. And of course, the return to travel has been very robust. We talked a lot in our Investor Day about ESG. And for us, ESG is not -- it's not a new item. It's actually something that we've been very involved in for over 15 years. And as we shared at Investor Day, over -- about 60% of both our R&D and our sales are in ESG-related solutions. And so that's helping both ourselves and customers. And in terms of the growth of the business, we've had very strong organic growth, about 5% per year without the -- with exception certainly of 2020 for COVID. And we've upgraded our financial model for the future to 4% to 7% going forward. And that's going to be partly due to a lot of the organic things that we have going on, and we're going to continue to invest in the business. That's what you get from Honeywell, both the long and the short term. We continue to drive margin expansion but also invest in our business for the future. And then lastly, around capital deployment. We talked about $25 billion plus of capital deployment. We highlighted our $4 billion share buyback this year, which we're well along on. And we raised our guidance by $0.10 at the top and the bottom for EPS to represent the share repurchase. So we feel very good for how we're positioned for what's to come in the next period. And then we highlighted as well in our Investor Day the transformation that we've been on. We've been on this path since about 2016. The last 5 years have been, in some ways, the great integration of Honeywell. We've done a lot of work around our supply chain transformation with footprint simplification. We've done a lot around our IT infrastructure, building our digital capabilities. We launched our Honeywell Connected Enterprise business back in 2018. So we really set ourselves up, and now we're ready -- we're coming down the effort curve, if you will, for this next period ahead, which should allow us to really monetize and take advantage of a lot of the value capture of the foundation that's been laid. We expect acceleration in our software business. And of course, this should free up some capacity also for our business leaders to deploy capital in a big way as we go forward and continuing to do that. It is important to us with M&A being a focus prospectively from here. So just very quickly, reaffirmed our guidance for both 2Q and for the year. Things -- the highlights are going to still continue to be supply chain and the environment more broadly. But we feel pretty good about where we are at this stage. So no change to our guidance as we sit here today. So I think with that, Nigel, we can jump into discussion.

Great. Okay. I'll kick off the Q&A. I'll give the room probably a couple of opportunities to ask questions. And if there's anyone -- on the virtual kind of side, if there's any questions, please e-mail us on [email protected]. Great. So Greg, you reaffirmed guidance. That's great news. Can you just remind us the range you have, flat to plus 4% ex those factors, minus 2% to plus 2%? Remind us just kind of gating factors at the high end and low end. Is it really mainly supply chain at this point?

Absolutely. I think we talked a lot about it during the course of our earnings season. For supply chain, for us, semiconductor is a little bit easier to see. The supply chain for aerospace, many more suppliers, a lot more variability involved. So that is going to be the main determinating factor of high or low end of guide. And we're -- as we sit here today, I mean, we're just about coming down the end of the stretch of May, of course, but roughly half of our quarter happens in the third month of the quarter as usual. So that's -- we're not going to really have the [ greatest ] indication of that until we get closer to the end of the quarter.

Yes. And I mean everyone is right now hyper focused on the macro, risk of recession. We saw one social media company last night missing the low end of their guidance [ before giving new guidance ]. So I think we're all a little bit tuned into short-cycle demand trends. I mean are you seeing any flickering signs of concern?

Nothing really broad-based yet. So, so far, we've really had very strong orders. We had good orders in Q1. We continue to see good orders so far. So -- and we're keeping an eye on that. We're watching because -- as you've seen, we've done very well from a price capture perspective, so we're watching for demand destruction as well. So we're keeping an eye on our win rates, our order rates, cancellation rates. And so nothing really big -- there's always going to -- in a portfolio as big as ours, 38 different GBEs, there's always going to be something somewhere, but we're not seeing any real broad signals just yet.

That's great news. And then you mentioned supply chain is key gating factor. You had some good news on chip supply during 1Q really benefiting HBT. How is that trending? Because we are seeing a lot of lumpiness around the chip supply.

Yes. So just for a little bit more color around chip supply even for us. So we're -- we've really taken -- I'll say we've got 3 factors going on into our chip supply. One is actually just getting -- during the course of last year, getting a longer demand profile to our supply base so that we're getting a better place in line for the capacity that they had. Two was we were really going out and doing some engineering to try to do some swaps for different chipsets into some of our products. And that takes a little bit of time, but that started coming to fruition right now. And then the third, of course, is actual new capacity going into the ground, which that's going to take on a longer time horizon for sure. So the first 2 are a little bit more self-help and working with our supply base to get access to more of the supply that they do have, and that's a little bit of the freeing up that you're seeing in Q1. So it's a bit better than the back half of the year. But the real improvement that we're counting on or expecting is going to be coming more in the third and the fourth quarter as real capacity comes back.

Okay. That's great. And that, of course, drives meaningful acceleration in the second half of the year.

For sure.

Yes. And then, obviously, China is the other gating factor around the quarter. I think you actually gave a date. I think May 8 was the date that you put out there.

Yes. We felt like coming out of the holiday that people were going to come back and start opening up. And we talked about the fact we've got roughly 20 sites in China. They're all operating at some level. There are a couple who have now come more up to full service in Shanghai in particular as of -- starting this week. So it's slow but so far, we're not seeing major disruption at this stage. I mean it's more than just the factories themselves. It's also actually the ability for logistics to move around through the cities. So this is one we're just going to have to be very mindful of. Back to the weighting of a quarter, it depends on when this happens, where it will have a big impact. If things are really jammed up in June and September and so on, it's going to be a lot more concerning. Right now, we feel pretty good about how things are loosening, but June will really be the telltale sign. And I think -- I just read this morning, I think, across China, there were under 1,000 positive tests this past week, which is the first time they've been under that in a while. So it seems like things are maybe getting a little bit better. But that can move around pretty quickly as we all see.

And China is 6% of sales?

Yes. It's a little higher than that, and we're about $2.5 billion, $2.6 billion. So a little bit greater than that but in that neighborhood, yes.

And you haven't got a huge China export business, too?

That's right. That's right. For the most part, China is really serving China. And so that's been something that's been advantageous for us. I mean we've always talked about our local-for-local strategy being pretty important. So yes, so it's not really disrupting our global supply.

Yes. I don't want to get too far into the long-term forecast here because I do want to touch on that a little bit later on. But when you think about your medium-term targets, I mean, obviously, in days gone by, High Growth Regions was a huge initiative for Honeywell. Do you still feel the same way just given the way that the EMs are trending, China, maybe some reshoring back to the U.S.? I mean how do you feel about that mix?

It's still important to us. I mean we still feel like there's going to be very good growth internationally. Doing business all around the world is an advantage for us and always has been. China looks like -- in general, the economy is slowing. And I don't -- I really can't say how much that heals and how quickly and whether it's going to be the same kind of a growth engine for the world that it had been in the 10 or 15 years prior. So will it be maybe a little bit less impactful than the last 10 years? Perhaps. But will it continue to be an important part of our growth strategy? Absolutely. And again, I think there's a lot of sustainability demand that will find its way into High Growth Regions, and we've got great relationships there as well which we'll take advantage of. So I think it's going to continue to be an important part of our portfolio.

Great. I want to go back to the FY '22 framework. You've obviously reiterated the framework. We've got some pretty big swings in 3 areas, Intelligrated, UOP and the military business, first half and second half. How do we feel about that where we sit today? And just remind us in terms of the [ staging post ] for that acceleration.

Yes. So I would say the -- as far as UOP is concerned, we're expecting to have a very strong second half for UOP. Our orders have been terrific coming out of '21. And the first quarter was down 9%, but again, we talked about the fact that 7% of that was just associated with Russia. So ex Russia, UOP should have a very strong year, but that is going to be an impact for them. I think we talked about Russia is about a $400 million revenue loss for us in 2022, a heavy part of that being UOP and a little bit in HPS, some in the rest of the business. But I feel very good about UOP. And again, I think with the investment cycle -- we've talked about this quite a bit, that there's -- it's not either/or. I mean there's going to be -- it's going to be a bold investment cycle for us, which I think will bode quite well. So I'm very bullish about how UOP will do, again, taking out the impact of Russia. Intelligrated, you guys have read everything that Amazon has said about their own overbuild. And so that's going to cause us to have a bit of a slower year this year versus what we maybe had 5 to 6 months ago. We talked a little bit about that in the call. The good news for us is that's not really a profit challenge. That's always been the lower end of the margin profile for that business and certainly for Honeywell. So that will slow down the top line growth rate. But again, we grew 50% last year. So if Intelligrated doesn't grow at a dramatic pace in 2022, that's not really a huge issue for us overall. We still feel like the long-term trend for e-commerce is very strong. So we're going to go out just like -- and mine the rest of the customer base. Amazon is not everything. So -- but most importantly, from a profit perspective, that should not be a huge issue for Honeywell also. And then the third one on defense, I think we've not seen any tick up in defense at this moment just yet in terms of the increased conflict. But I don't see how that's not going to happen. I mean with the amount of munitions that are being provided to the Ukraine in this conflict from around the world is going to have to cause the full defense industrial base to ramp up at some point to replenish what's being delivered. So we're very strong in certain platforms as it relates to tanks and so on. And so I expect that we'll see a strengthening in that business. Certainly, we feel stronger about that today than -- again, than we did 3 months ago or 6 months ago. We're all obviously hoping for a peaceful resolution of what's happening in Europe. But obviously, that's going to be a demand driver here.

Yes. Quickly on UOP. It feels like the refining margin is exploding, fuel shortage around the globe. It seems like there should be a really, really great environment for UOP. Are you starting to see some of that benefit perhaps coming through in orders?

Well, yes. I mean, again, I think our order book is actually very strong, particularly in the catalyst business. We feel like there's going to have to be investment in that area, and that's a great business for us. We have got a great position. Our technology is superior to tech that's out in the market. So UOP is frankly one of the highlights when you think about the STS aspect of that as well, put that on top. That's kind of why I was mentioning it. It's a bit of an [ and ] for UOP. So we talked about growing the STS business at a fairly high clip, maybe 50% per year over the next few years. So I think the story for UOP is going to be a great one over the next few years.

Great. I'll take a couple more questions, then I'll [ move ] to the room so get your questions ready. Just to clarify your comments on Intelligrated and SPS. It seems like revenues might come in a bit weaker given your comments, but margin is a bit stronger, net-net; EBIT, more or less in line with plan.

Yes. It's not exactly -- I wouldn't call what's happening at Intelligrated really a change at all to our EPS skew for the year. But is that going to be one of the things that could bring us -- have us tick down in terms of where in the sales range we turn out to be? That's for sure.

Great. And then on free cash flow, you have some -- obviously, some cash down in 1Q.

Yes, as did everyone. I mean I think...

[ It looks like ]...

That's right.

Are you comfortable with where they are today? And have you kind of gone through that process [indiscernible]...

Yes. To say comfortable -- this is a big topic of our operating model right now because, if you imagine the supply constraints through the supply chain and you're missing, we determine, like the golden screw, you have 99 parts but you're missing 1. So what you wind up with is quite a bit more raw material and in some cases, work in process because of the fact that you can't really depend on all the parts coming in. And so we're struggling through that. Again, that's been one of the reasons why we've had -- we've got demand -- we've got more demand than we know what to do with. We talked about $20 billion backlog. And so knowing which parts are going to come in or not is a bit of a challenge. I expect as the supply chain performance improves, then we'll start bringing down the backlog and therefore inventory with it, which is why you see a little bit of that similar second half weighting on the cash flow side as well because it's got to be through a reduction in our inventory as we head to the remainder of the year.

Makes sense. Makes sense. All right. So Federico has got the mic here. So hands up if you got any questions. Right here. Over here.

Can you guys hear?

I can hear you.

Yes. Just wondering, can you size the defense-related restocking opportunity from the Ukraine conflict?

I really can't at this point. To me, it's just a matter of I know it's going to be there. It's going to depend for -- I'm sure, for all the different OEMs, on what their platforms are and what comes through. So I can't really give you a value for that right now, but it's something that we feel is going to probably start showing up in the back half of the year from an orders perspective.

And then just platforms that it would be tied to at least?

Yes. I would say anything that's going to be related to the Army, the Abrams tank, some of the air equipment, so munitions, that type of thing.

Labor constraints has been a headwind and pressure for your commercial aerospace business. Has there been any signs of improvement? Particularly, I guess, it's been more at your suppliers. But have you seen any thawing out in that situation?

Yes. We're seeing an improvement in the second quarter vis-a-vis the first. Particularly in the early part of Q1 with Omicron, that was really challenging from the supply base standpoint. And we talked about the fact that the de-commit rate from our suppliers had gone up to something in the mid-20s, about 24%. We're starting to see that come down here in Q2. So it's performing a bit more like it had in the back half of last year. So I would say it's settling back into better than Q1, but we still expect to see -- or need to see that to continue to improve in the future. That -- it's really -- that's a really difficult one to call because, as I mentioned earlier, that's many suppliers and that labor shortage is really hard to size.

One more.

Greg, I saw in your slide there the $25 billion capital deployment, the new plan. I believe it said the prior long-term plan had no indication or no allotted amount. Maybe can you describe why the change there and how you think about capital allocation in general?

Sure, sure. Well, first of all, we think that deploying our balance sheet has always been something that's a big value driver for the company, the possibility of doing that. As I talked about with the -- our transformation journey, I think we were, during the course of the last 5 years, doing a lot of work internally, spinning 3 companies, going through all the integration that we were going through. Now our capacity to go and deploy capital to a greater degree, I think, is going to help us. It's not that we didn't want to deploy capital previously. We always have had that as part of our algorithm. I also think with valuations coming down, we would expect that at some point in time, things will become a little bit more actionable. And so we want to continue adding to our portfolio. And so it's not really a difference in terms of our willingness or desire to deploy capital. But I think our capacity to go do so is going to be greater in the next 5 years than it was in the last 5.

Any more or are we done? Yes? Mic please.

On the automation side, some of your peers have done software deals, so whether it's Emerson-Aspen or Schneider-AVEVA, et cetera. I'm curious where your thought is on software in the automation portfolio and whether you feel like you want to look toward that as an opportunity for capital.

Sure. Yes. I mean if you think about it, we did the Sparta acquisition about -- just a little bit over a year ago, which was a fantastic deal for us. It's actually accretive at this stage already to EPS, which is not an easy thing to go do when you're paying high multiples. We spent over $1 billion on that business, I think about $1.3 billion on Sparta. That's actually a really nice model for the kinds of software deals we would want to go do. It's got a good revenue base, around about $100 million. It's in a bit of a regulated environment, in the QMS space. It's very sticky from a customer standpoint, and it's something we think we can build around. So that's an ideal profile, and that's a good size for us in terms of the amount of capital that we'd be willing to go and spend on any one software deal. I mean we are not looking to bet the farm on software. When we think about our overall capital allocation strategy and how we think about M&A, we think it's going to be a mix of some software, some, I'll call it, traditional and perhaps some things that are maybe more in a little bit of a sustainability theme. So it's definitely going to be part of the mix for us, but it's not -- we're not like solely focused on software specifically.

One more.

Greg, just a quick question on Quantinuum. I noticed that Quantinuum sales were around $1 million for the quarter and you anticipate about $20 million in sales for the year. Do you still think that's a reasonable target? Or do you think the environment has shifted such that the ramp is more difficult?

No. Listen, I think we're dealing with relatively small numbers right now. So I wouldn't read too much into any one period for Quantinuum given where it is in terms of its life cycle. So we still expect to be in that $20 million range for the year. And we feel good about the offerings that we have out there. I mean when you think about the value of Quantinuum, what we have is the most powerful quantum computer and we combined it with CQC, which brings a software element to it. So having that combined capability to bring an offering to the market is what we think bears a lot of strength. And we're starting out in a very good space from a cybersecurity standpoint. Our cybersecurity offering is something that's already out in the market. We think it's going to have good draw to it. So again, 1 quarter, early on, $20 million for this year. We still feel pretty good about where we are.

Right. Good questions. I want to stick with Quantinuum. Obviously, the sales ramp is pretty significant beyond 2022. I don't know if you want to address that in terms of the confidence in that ramp. But I'm just -- I'm more curious actually on the investment requirements. We've got $150 million [ of pinch ] this year. Is that a run rate at this point? Or do you think investment requirements could actually expand from here?

I think they'll expand but it won't be like a doubling. I think our investment in Quantinuum will probably go up each year, but I would think about that as something like in the -- maybe the tens of millions of dollars type of range. So -- and I think that's a healthy thing, and we can certainly bear that in our overall profile -- financial profile. And like we talked about, we think that, that is a pretty prudent investment overall for the option value that we believe that can deliver. So yes, that's sort of how we see it at this moment.

Okay, okay. And then bringing in external capital, obviously, you've got the Cambridge computing kind of partnership, if you will. But what about maybe -- you've talked about maybe finding a solution in terms of partial separation of this business, maybe bringing in some more capital. I mean is that still an option?

Absolutely. I mean that's -- we tried to highlight that a little bit in an illustrative manner in my slides in Investor Day, which is there's going to be a time and a place where Quantinuum will be better served not being majority owned by Honeywell. And that will be dependent on how the public markets are behaving at that time as well as what the development of the businesses, the management team, et cetera. And we expect to monetize that over a period of time, and that really is going to provide more cash to Honeywell to invest back in our base business as well. So you can almost think about that as an option with a cash inflow attached to it that we can then turn around and reinvest back in our base business.

Yes. I mean certainly, if you get to $2 billion of sales in the next 2 or 3 years, the 4% to 7% organic growth doesn't seem like a huge target. So that's the key, right, to get into those targets.

I don't think Quantinuum is the key to getting to 4% to 7%. I think we feel like we can get there with the base business that we have.

So that will be upside to that number?

Again, I think that may be part of it, but I believe our range really incorporates us being able to get there from an organic perspective.

Okay. That's fair. We're getting down the sharp end of the fireside chat so I want to touch on portfolio very quickly. You've been very open about the fact that portfolio work is never done, the review process is continuous, et cetera. Where do we currently sit today in the portfolio? And how has the view evolved since the last big review in 2017?

Yes. Well, again, I would tell you -- so the last big review in 2017, we -- as you mentioned, we reviewed every year. And in fact, we're -- we'll be talking to our Board again here coming up around our strategic plan in the summer as we always do. I would say to you that there are always -- back to 38 GBEs across the whole company, so there's always certain things that are inflecting upwards and others that maybe are not necessarily as great of a fit for the portfolio as they once were. But I would say, at this stage, the revenue attached to that is probably something less than 15% in total, and nothing -- no one big slug that we'd be looking at specifically. But timing matters a ton, right? You want to -- when you take some of those actions, the inflection of that business and where it is, is going to really matter. We're not looking to ever divest something and give away value. So it's always a bit of a tricky one to call as to when the right time to take some of those actions are. And we're also interested in growing the company, not just shrinking it, too. So matching ins with outs also is helpful as well.

Yes. So obviously, organic growth is a much sharper focus for Honeywell today than it maybe was 10 years ago, but also margins are still moving higher. And you've got a lot of confidence in margins. And you've raised your Aero and HBT margins by 2 points relative to 2019. Maybe just touch on what got better. What gives you more confidence that these are more profitable companies now? And then if you can just touch on the pathway to high teens for SPS.

Yes. So for Aero, in particular, I think we've got a lot of leverage in this business. We talked about some of the cost reductions that were made during COVID. We took out $1.6 billion of cost, about $1 billion permanently. And if you kind of go back to who is most impacted by that, Aero, PMT were on the top end of the impacts, and therefore, they probably had the most of the cost reduction that we did. So there's a leverage point with aerospace with that return to growth. HBT, they've done a great job in their portfolio as well. And a lot of the newer offerings that you're going to see growth coming out of are going to be really more software and just higher margin oriented. So we feel like that runway, also very strong. And again, they're already in the 22% range at this stage. From an SPS perspective, we've talked often about the strategy with Intelligrated, capturing the installed base, coming behind with the service and software aftermarket. By the way, that's growing quite nicely. That LSS business that we have is close to $400 million at this stage and growing at strong double digits. So if you think about what we talked about as far as the build-out slowing down, actually, that will likely increase the pace at which the margins improve in SPS because that will lift Intelligrated a little bit faster than it otherwise would if we were still at a really high growth clip on the projects businesses. And the underlying products businesses inside of SPS are all having nice growth, and they're all very high-margin businesses. So I actually -- I feel very good about where that business is going. George Koutsaftes has now taken over that business, and he's putting a lot of energy and focus around operational excellence. I think that's going to be great for us. John is now in corporate, really driving our overall commercial strategy, which is going to be great for us. So I think we're in a very good position.

We're out of time. That tone was telling me to get off the stage basically. But I do -- I'd be remiss if I didn't touch on ESG quickly. I mean the SEC is cracking down ESG disclosures, but I know this is very important to Honeywell. Maybe just discuss how deeply embedded this is in the strategy.

Well, again, I think the numbers tell the story. I mean like we talked about, about 60% of both our R&D and our sales are in ESG-oriented solutions. So just by that -- by virtue of that in itself, it's part and parcel of what we do. It's been an important part of our company and our strategy probably since the early 2000s. And so for us -- I mean Solstice is a low global warming molecule, was big for us. We've effectively invented the sustainable fuel market. So many of the technologies that are inside of Honeywell are very much tied to sustainability and always have been. So I think a lot of people are doing it now because they have to. We've been doing it because it's actually been part of the strength of our portfolio.

Great. Greg, we've got to stop there. Thank you very much for the time. Thank you.

Thanks.