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

That makes sense. And then can you talk a little bit about pricing? Maybe how does pricing compare to pre-pandemic debt levels? And what are the sort of actions you're taking to mitigate inflation as well?

Yes. So I'll start with the contracts. Because so much of our business is under contract, all the OE business is under contract, and I just kind of ran through the numbers on the aftermarket side. There's a couple of advantages to that. One is most of our contracts have an index-based escalation, an index tied to material and labor. So we're able to pass along what the market is doing in the form of price, not always at the level we'd like to. In some cases, when you see inflation take off at the rate we've seen it the last 12 months, those indices lag a little bit. Similarly, on the buy side, over 80% of our purchases are under contract, so we have the same sort of security on the supply side. So they tend to be kind of back to back. They both move with the market cost and price. But what we have done is, I mean -- and it's no secret, I think it's probably pretty common with our peers as well, is we have seen very significant price escalation from the suppliers in almost every area. We've pushed that through in the form of not only the indices and the contracts, but catalog price increases, labor increases on repair and overhaul work, and then surcharges that we've pushed through as well. So we're doing this to ensure that on a margin basis, our price will stay ahead of cost. And so far, we've been successful doing that.

No, that's great. And then can we talk about the aftermarket from a regional perspective? How closely has the business followed what we're seeing in global air traffic? And when do you kind of expect aftermarket to return to 2019 levels, both domestically and internationally?

Yes. I would say we model -- we take -- the way we look at this is we take data from OAG and IATA. We call about 50 airlines once a month and talk to them about what they're seeing in terms of flying activity, load factors, because sometimes we get data in terms of RPKs, right? We have to use the load factor to back end to flight hours. We look at ticket sales. So we take the industry data, we take individual inputs from about 50 airlines and we pull all this together monthly. And Dan and I just had the review yesterday with the team on this, in fact. And we model what we think flight hours are going to look like over about an 18-month horizon. And then every month, we look and see how it compared to our predictions. So far, it's been pretty close. What we thought would happen collectively as an industry and individually as a company has been more or less consistent. The surprises have been China this year. China is down because of the persistent COVID lockdowns. That's lower than we thought it would be if you looked at it 6 months ago. Saw a little bit of a hiccup in Europe, in the March, April timeframe due to COVID, due to the uncertainty with what was going on in Ukraine. That seems to have stabilized a bit. I wouldn't say it's come back, but it's stabilized. What we see in the rest of the world, the Americas, Latin America and the rest of APAC has been very consistent with our modeling. So when you -- what does that all mean? What we're seeing is flying activity is back almost all the way to '19 on narrow-bodies, I'd say still about 65%, 66%, somewhere in there on widebodies, but highly variable, much, much lower than that in China and higher than that in Latin America and outside of Latin America in APAC. So closely coupled, our revenue tends to be pretty closely coupled to flying activity. If you think about that commercial aftermarket, air transport aftermarket business start with air transport, a portion of that, sizable portion of that, more than half is on a cost per flight hour basis. And that business tracks 1:1 with flight hours every month. So it's very closely coupled. The portion of it that's not tied to flight hours still under an agreement, but the business shows up when the unit comes off wing, you have a little bit of a lag there, but not a significant lag, a few months. On the Business Aviation side, almost all of it is on a cost per hour basis, so it ties very closely to flying activity. So really, the only nuance for us is forecasting event rates on the air transport aftermarket that's not under a cost per hour agreement, but we've been doing that for a long, long time. So it's pretty well understood. What we're not seeing is any sort of acceleration of returns or spares purchases. We're also not seeing a lag, which would be indicative of cannibalization of older aircraft or anything like that. We're watching that. There's always some small cannibalization. There's always some ongoing retirement of platforms and they pull aircraft -- pull parts off those aircraft, but we haven't seen a real step change up or down in that. And time will tell. I think if the demand stays very robust, capital costs remain reasonable. And if fuel prices go up -- back up significantly, then in another 2 years or so, we may see an accelerated retirement of aircraft. And of course, if these things go the other way, we'll see just the opposite. But so far, not really, we've been kind of waiting for an inflection there. We haven't seen it.

Yes. That makes sense, and that's super helpful. One thing I wanted to talk about because it intersects both your segment and PMT is sustainability and staff. And I think this is a really neat opportunity for Honeywell. How do you think about the opportunity for SAF and how you're cross leveraging?

Yes. So I'll tell you, I'm a big proponent of SAF. When you look at -- we all talk about the fact that I think aviation is like 3% of the global carbon emissions depending on who you talk to, it's 2.5% or 3% or 3.5%. It's a pretty small component. But we have to do something about it. We can't just say, well, the cement industry or the steel industry has to solve the problem. We've got to do our part as well. One of the neat things about aviation is that cost reduction goes along with fuel consumption reduction, which goes along with carbon reduction. So at least the incentives are aligned. And so more efficient aircraft, energy savings, mods and upgrades, even things that are more subtle like weather radar that allow you to fly a more direct route, saving a few minutes on a flight, these all help. Doesn't -- 3% isn't an enormous amount, right? When you think about it, but when you add up all the airplanes that are flying, it's a significant amount of carbon. So that's one area. But in terms of SAF, specifically, I think it's the easiest way to get to carbon neutrality for aircraft. As long as you have feedstock sources that don't compete with food, don't compete with other forms of land use that are needed to address other parts of the economy. It's a much easier play than hydrogen. I don't want to get into the physics of it. We like hydrogen for small power, think battery replacement sort of technology. Tens of kilowatts, hundreds of kilowatts, maybe a megawatt even. But using a fuel cell or compressed hydrogen or liquid hydrogen makes a lot of sense as a replacement for a battery supplement to an APU and a hybrid power system. That makes a lot of sense. But when you talk about powering an aircraft the size of a 777, hydrogen in a liquid form per gallon has 1/3 the BTUs of jet fuel. So you can imagine the size, how big the airplane has to be to hold enough fuel to get across the Atlantic. So it's going to limit hydrogen. If you're talking about burning hydrogen, you're going to -- as a propulsion source, it's going to limit it to a very large aircraft. Doesn't mean it can't be done, but when you couple that with the infrastructure of storing and transporting hydrogen and replacing fuel terminals, it's a pretty big deal. SAF, on the other hand, you can produce it at a reasonable cost. It's interchangeable with fossil-based jet fuel. And you pour it in a tank and off you go. Our APUs will be certified to run 100% on SAF by the end 2025, so 36 months from now, less than that. And then it will be a pretty easy pipe to get the business jets there as well. So I think that my view is that's a fairly low risk and effective way to get to carbon neutrality for propulsion engines and large power consumption on aircraft. We are partnered very closely with our PMT group. The PMT organization really invented the process for making green jet fuel, developing jet fuel from all sorts of feedstocks and molecules, whether it's grease and fats or Jatropha or algae, you can start with almost anything. We've expanded that process over the next -- last 20 years, that is with Alder Fuels, for example, the partnership there with United Airlines. So Vimal and I and Doug and I now are very closely partnered on that, that whole side of the business to work with our aerospace customers on adoption of SAF.

That's great. Maybe transitioning to defense. You laid out potentially growing low single digits and maybe mid-single digits. What gets you to the high end? And when we think about the strong content platforms that you have, if you could highlight a few of them and maybe ones that are transitioning down?

Yes, a few things. I mean over the last couple of years, the last 1.5 years, it's been sort of a pivot. Last 20 years, we're really a counterinsurgency defense posture for the United States, heavy reliance on things like JDAMs, Tactical Tomahawk, platforms, fifth-gen fighters like the F-16, F-15, CH-47 Chinook, the AGT1500 tank engine in the M1 Abrams tank. Now what we're seeing is a shift more toward a near peer posture, which is placing greater emphasis on the Joint Strike Fighter. Still a lot of need for the Chinook, but also the B-21, the ground-based strategic deterrent, the recapitalization and modernization of the nuclear triad. So still a lot of our products involved when you talk about the U.S. DoD, but a little bit of a shift towards the newer stuff. So we're pretty excited about that. We're excited about the win that we have with Boeing and Sikorsky on the FLRAA. I think that's going to be a relevant platform for rotorcraft as we go forward, when we look at the conflict posture that we'll have to deal with in the next 25 to 30 years. I mentioned the B-21, I mentioned GBSD, but also inertial navigation for launch vehicles. satellites remain a strong part of our business. We're the world leader in satellite pointing and positioning stabilization with our control moment gyros and reaction wheels. Those are starting to see commercial adoption now on commercial satellites. So that part of our business will be growing. So what you'll see is I think JSF will remain strong. Chinook will come down and then level off and may come back up. Then we'll see a B-21 GBSD growth, growth in launch vehicle activity associated with the next generation of satellite constellations going up, which is for us, both launch vehicle parts as well as satellite stabilization and pointing components, RF components like optical interlinks will be a growth area for us. And then on the international side, we have a lot of business with international MODs for both inertial products, but also propulsion, the advanced jet trainer with Taiwan, the M346 platform with Taiwan both has our F124 engine on it, and we're seeing growth there, too. So a little bit of a shift. It's good to see some stabilization now in the outlook and the priorities.

Maybe one last one for you on profitability. I remember at the Analyst Day in March, somebody started interrogating you about your 29% margin target and insinuated margins could come down. And I feel like the discussion has changed now about potential expansion beyond your targets of 29%. You're at 27.7% this year, about that. Can you talk to us about the path to getting to 29% and potentially higher?

Yes. I think it's interesting because if you look at it, we've had nice margin expansion over the last decade. Even through COVID, pre-COVID, we were 25.7% and now we're in the 27s. And so there's a temptation for folks, I think, to look at that and say, "Well, is all the juice gone?" It's not. There's a lot more opportunity. One of the areas we're really focused on is digitizing the business and focusing on more machine-to-machine interactions with customers and suppliers. This is really, I think, not only a way to address fixed cost, but it makes the business much easier to conduct. If you think about when you use Amazon, do you really want to e-mail a purchase order to Amazon or call them up and order something? No, you just go online. You order it. You can see the status. It tells you what else you might want to buy along with that product. That's sort of what we're going for. So we have a portal now. We've had it in place for quite some time. It continues to be enhanced based on customer feedback and customer forums that we conduct on that; same way with our supply base. And about 80% of our transactions today with customers are machine-to-machine. But as that expands and as it becomes easier to use, I think it's not only a cost enabler for us, but it's a growth enabler for us, especially internationally. And then also, I would say, just digitizing the business, supplying forge technologies to our factories, discrete manufacturing processes, helping our suppliers do that, it's all going to reduce our cycle time. It's going to reduce our cost and in particular, the amount of effort that we spend just managing those activities internally. So there's still plenty of room for margin expansion for us. Of course, price is the lever that we're not afraid to use in this environment, you have to. And so I think those are opportunities for us. So despite the fact that we're going to be increasing our investments as a percent of sales over the next 5 years, we're going to continue to see that margin expansion.

Yes, that's great. It sounds like the Honeywell Aerospace story is on track and lots of growth opportunities ahead across the board. Thank you, everyone. Thank you, Mike.

Thank you.