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

Welcome, everyone. Thanks for joining us here this morning. My name is Peter Arment. I'm the Senior Aerospace Defence Analyst here at Baird. We are delighted to have Honeywell International here with us. And with -- from Honeywell, we have the President and CEO of Honeywell Building Technologies Doug Wright. Doug is a long-time industry veteran, 16 years. I think in so ran half a dozen years at UTC and another other bunch of other companies around the industry and he spent 8 years in China. So he is a wealth of knowledge, and we are absolutely delighted that here. So we're Doug,welcome.

Thank you, Peter. Like to see everyone.

Thanks again. So I want to start high level, just kind of talk first kind of end markets, if you don't mind. Maybe just what you're seeing from a demand standpoint in the commercial building space. And if you want to like think about it from just a regional or global, breaking them around the globe, that would be great. I think helpful to level set up.

Sure. I would say, in general, demand in -- with the exception of Europe, demand in the world is kind of pretty stable in the high-growth regions, which we define as kind of India, Middle East, China, kind of Southeast Asia, we're still seeing mid-teens organic order growth across our entire Honeywell buildings Enterprise. Europe is going through some challenges, particularly with the energy transition there and some of the impact of the situation there. Nothing really falling off of a cliff, but there's clearly some softening there. North America is still quite solid. In our -- I mean, talking about our order growth rates, we're -- we have to factor in that our backlogs are coming up such a high peak from a couple of quarters ago that sometimes it's hard to see in the order trends because we printed 3% organic growth as an enterprise in Q3, but still mid-teens for the year. So what really happened was is that there was a lot of -- it wasn't really a channel inventory provisioning. It was really, I think customers are giving us less lead time now because they know that the supply chain is getting a little bit better. So -- so overall, I think Europe is kind of our -- kind of our yellow flag that we're kind of monitoring the rest of the world is still quite strong.

That's excellent. You mentioned the high-growth regions. Just how should we think about just -- Honeywell has always kind of had this focus in the high-growth regions and it's really kind of continued to grow exceptionally over the years. But just how do you think about it in your framework?

So first of all, Honeywell has a pretty long history of being in a, call it, challenging parts of the world to operate for decades. And so we have -- we're driving a little bit almost 1/3 of our growth out of high-growth regions. And it's really, I think, a differentiator for Honeywell. And I'd say that as someone who competed with Honeywell in these regions in a good part of my career. We play a long game. We invest in talent. We invest in local production capabilities in most of those places. China, we're almost completely localized in our product portfolio. India, we're manufacturing a substantial portion of what we do there. Even in the Middle East, we're building -- we're provisioning now to start having local products there. So it's part of our nature that we are -- we go local for local, probably earlier than some of our counterparts. And that really benefits us when we go through these cycles where there's still really strong demand available to us to go tap into those markets. And when developed markets slow down, it gives us a bit of a buffer to balance the portfolio out.

And is most of the growth in those regions just new product adoption? Or how do you think about that one.

Well, I mean, I mean, we said the normal trends that have been secular for a long time, urbanization, whether it's in the Middle East, we've been very active in Egypt recently. They're doing a lot of new city development. China has been on that trend for a long time. I think what's really probably the most interesting right now in high-growth regions and maybe it's not well understood is that -- they are -- all of them are just as active in green -- the greening of their built environment, the commercial buildings as is in the West. I mean, China is probably the most aggressive at provisioning for putting technology in the buildings to manage their carbon commitments, even in the Middle East, which is -- which surprised me over the last couple of years is that they become very focused on greening of their building. And so sustainability, which we started the new business unit earlier this year, that was really an intentional investment to prioritize sustainable buildings and the HGRs are actually -- the high-growth regions are actually, in some ways, leading that charge because they have a little bit more bias towards new construction. So the adoption of new technology is a little more straightforward than in more of an aftermarket situation that we have in Western Europe, as an example.

Do you expect just kind of staying within -- just thinking about private institutional kind of nonresidential end markets. How do you think the differences are between like, say, private versus nonresidential end markets when we're kind of thinking about a potential economic slowdown as we get into next year?

Yes. We've been having this discussion quite a lot internally that -- so we look at the macro data in places like Europe that's starting to flash some yellow signals or the private investment, whether it's commercial real estate, residential particularly, we're not really -- we don't have an exposure to residential, but in privately owned real estate, corporate call the CRE market, they'll be affected by interest rate policy and by the economy just like you would expect them to. But institutional demand is actually accelerating. And part of the reason is that the institutional buildings are generally owner-operated and they are quite concerned about their energy cost and their sustainability objective that you're getting from the whatever government -- all the regional governments are driving codes and standards around energy consumption and buildings as an example. So I think there's -- institutional demand is quite strong. And then just because of the policy, so you have Fit for 55 in Europe, you have the IRA in the U.S. you have China green building standards. There's a lot of, I'd say, prioritization within the regulators. But then you have this unique situation where a lot of stimulus came into the economies before we had any recession signals with -- because of the pandemic policies. So there's a huge amount of investment in the pipeline for K-12 schools in the U.S. or hospitals in Italy, and we're seeing pockets where the institutional demand is still quite robust. A big part of our business is institutional building. So we feel like that will buffer us a bit from some of what we're going to probably see in the the private side of the construction economy.

That's super helpful. Let's talk -- it's -- so you competed against Honeywell and now you're with Honeywell. So let's -- how do we think about HBT is kind of how they differentiate from just, say, other HVAC players or other power equipment players? How do you frame it up?

So we're not an HVAC business. We don't -- we sell -- we install and maintain HVAC equipment in our service business, which is, I mean, our direct service business is $1.5 billion enterprise. So we certainly service HVAC and we provide. But our differentiation is a work controls company. We do automation and controls and whether that's through traditional controls or through now more software and artificial intelligence-based controls, that's really our value add to our customers because if you think about the sustainability problem in a building, we have 2 issues. First is the efficiency of the equipment and the other is how much you use that equipment. So one is sort of I need a better -- I want to put in a variable speed drive or a more efficient chiller or better lighting system to take out the thermodynamic efficiency benefits that we can get from those things, and we benefit from those, and we provide those to our customers, but we don't -- that's not our kind of engineering edge. Our technology edge is the controls. So for every building that doesn't have the right level of controls in it, it's wasting a lot of energy, overcooling, overheating, overfiltering, overlighting. And we -- through controls, we can differentiate. So our heritages is in controls. And one of the advantages that gives us with our customers is no matter what investments they've made in their built environment, our job is to come and make it better. And we do that through controls. We have our opinion about which equipment is best, and we have different partnerships in different parts of the world. But we have to be -- we're agnostic to those choices. So it gives us a little bit of a -- probably a more position of trust with our customers. It allows us to be a little bit different than the traditional players.

Right. And maybe just in this era of cloud and SaaS and your kind of SaaS capabilities, maybe how does that allow you to kind of really differentiate?

Well, I think it's really a couple of things. Number one, we were able to use SaaS or software technology really in 2 ways to really create a lot of productivity for the customer. One is that we can automate things to -- there are 2 big issues that most of our customers are dealing with. One is the sustainability problem we've already talked about, but the other is labor shortages. Technician labor for buildings in any service industry, but particularly in building service initiative pretty highly technical jobs for service technicians to have. So we can use software to automate, we can use more remote, we have technology to allow us to remotely diagnose and change set points and we've proven with technology that we can reduce our truck rolls. We have service technicians all over the world. And we have -- sometimes we have to do traditional service, rolling a truck and repairing something. We've been able to reduce our truck rolls by nearly 60% by having automation and remote management capability. And then the second real advantage that we bring to the table as a country is that artificial intelligence. And if you have -- once you get the architecture of your system so that you can talk to everything in a building, you can apply AI, ML capabilities. And what that allows us to do is introduce new controls that don't exist today. So I can now optimize between air quality sensors, lighting controls, motion sensors and HVAC. I couldn't do that with -- in the traditional where each system was independent with its own kind of what we call deterministic linear algorithm running, high-low kind of set points. Now with better software, we can now solve problems that we couldn't solve today -- before. We can now optimize between air quality set points, which are really important in schools as an example right now and energy. And there's a -- traditionally, we would just open the window or change the luber or change the thermostat. Now we can automate that and we can actually deliver better value with software.

Right. Right. Thinking about my old school, I think he was never right here all that. This is a big audience here. So maybe some may not be familiar with some of your wins, some of the recent developments that you've had. Maybe you could highlight a few of those just I think, as you have such a broad exposure here.

Yes. I think probably the one -- the area that we're most engaged in with sustainability is we're doing a lot of work with schools. So an example would be -- I think one we're using is the Phoenix Union School District, where this is a legacy customer. We've been servicing their HVAC and their lighting and their buildings and their security systems for many years. And with the pandemic, we had a new problem we had to solve and that was that the air quality standards have been raised by the regulators. We're measuring -- we're having to now measure things like PM2.5 and VOCs in the air that we didn't have to do before. We were just managing CO2 for basically for efficiency performance. So we had introduced -- we've introduced new technology that allows the customer to optimize their air quality set points and their energy consumption and let them have visibility to -- and make better choices about which playbook they want to run. If kids are in the school and they want to meet all of the current [ ASR ], air quality standards, which are a lot stricter than they were before the pandemic, then they can set that -- they can choose that set point. But when the kids go out to recess out of the room, they can now -- the system will automatically ramp down that air flow and, therefore, that energy consumption that's cleaning that air. So we're able to now give them a -- help them square the circle, which is how do I not have my energy bill double when thermodynamically if I want to -- I want to have twice as clean air, I need to, but I can use controls to now balance that equation better. So that's one example of -- and we're dealing with school systems all over the country and a number in Europe where we're deploying this new kind of AI software capabilities to optimize their system. So we're pretty proud of our work there with the Phoenix Union and there's a number of other school systems that many of you probably send your school -- your kids to that we're also actively working with the same type of technology. I think the other area that maybe outside of the sustainability equation is, I think we also are -- I mean a very significant part of our business is actually like safety. And we're a leader in the fire protection business and we take a lot of pride in the fact that a lot of the work that our team members do helps protect our families and our communities from fire risk. And we made an investment recently in a company that is allowing us to now take the technology that we have in the building and connect it to the first responders in an automated way. So now we believe that we can, through technology and software, we can now get a first responder to a scene of an incident faster in a matter -- in this industry, seconds count, if a house is on fire or if someone is having a heart attack, the faster we can get first responders to the -- and what we -- the way I would sort of articulate it is, is that we look at these ecosystems as an opportunity to use automation and controls and software to solve a problem. So whether I'm solving -- it's actually the same concept that we use to reduce the energy consumption in the building and balancing air quality. We do use the same concepts from a software and a digitization standpoint to actually allow that system in the building to give information to a first responder on their way to the route. So -- in fact, I'm going to be meeting tomorrow with some folks, some fire department here in Chicago and talking about technology with them. So this is an area that I'm pretty proud of that the team has done. And while we talk a lot about sustainability appropriately, I think we also recognize that we're an important -- we bring a lot of digitization to our life safety technologies as well.

So your last stat I saw was that roughly 10 million buildings roughly. I think is a number that I've seen historically kind of an installed base in general for HBT. So how do you think about the differences and just sort of like those examples like retrofitting versus kind of new building disruption?

Well, of course, the majority of our work is in existing buildings. In the high-growth regions, it's more biased towards new construction. And it's -- frankly, new construction is easier to deploy new technology in. And I think what art form is to be able to bring the benefits of the technology that we have into, let's say, a hotel like we're standing in today, to be able to bring the benefits without breaking the bank because you can't just go rewire everything and put in new systems, the cost is too high. So majority of our work is in legacy buildings and we go into a typical school system, they'll have 400 buildings, use places like Miami, Dade, 400 buildings. They've got 7 or 8 generations of technology in those buildings. And we have to come in, figure out a way to attach to that and control that because we can't just say we're going to be sustainable buildings for the new kind of big corporate headquarters like we have in Charlotte. We also have to go to the 1960s construction elementary school down the street here and also help them solve their. Now realistically, we can't do the same carbon mitigation because there's limitations to what the base building can -- how the base building can perform, but we have to figure out a way to do that. And most of our work is actually in dealing with retrofitting existing buildings, not the new construction.

That's helpful. Maybe we could talk about some of HBT's kind of breakthrough initiatives that's allowing you to kind of impact your -- and drive growth? I know you've got a number of different initiatives going on with that.

Yes. So we use -- we have this concept of Honeywell called breakthrough initiatives, where we we -- it's really an organizational model. We try to -- how do you -- in a large enterprise with 20,000 employees, how do you create an incubation capability to protect new ideas from the bureaucracy and systems of a big organization. So we use -- we call the BTI teams and our sustainable buildings group that's now going to be a $1 billion business in a few years, that started out of a breakthrough initiative. It was, "Hey, how can we take -- we had some technology over here. We have to go learn about a new way to apply it into this new value proposition." So we form a team and it started out with literally like 3 or 4 people, and now it's a big organization that's now being instrumented into the main army. The one we're working on now is, we have another active BTI where we are actually trying to -- the example I talked about with the life safety, where we can basically provide technology to first responders, letting them know where people are in a building. So our systems can actually -- we can tell with some sensor array in this building, we can see which buildings -- which rooms are occupied, that's useful information to a first responder before they arrive. So we've got a BTI working on that. And we have another one that is working on a new technology. So these -- everybody has -- we promoted these plug outlets in buildings today. Well, everything that's plugged into 1 of these outlets is actually consuming power, even when it's not being used, it's called parasitic power loss. In some buildings, that's actually a fairly significant portion of the carbon or the electrical consumption. In a school, particularly, there's always a lot of things plugged in and the rooms unoccupied. So we actually have a new BTI we just kicked off recently where we now actually control that. So we can connect that system to our control system and know that, okay, this room is unoccupied. So turn off the music amplifier in the music room of the school, which is only occupied for 2 hours a day, but that equipment is always plugged in. So that's an example. That's actually a -- so we have a legacy business that just makes electrical equipment plugs that go into buildings. It's actually a big business in Europe. It's not so big here in the U.S. And our team basically has come up with an idea that they can now turn that off remotely through controls to save -- and we've demonstrated that we can reduce the electric consumption in some of these locations by 20% just by -- with no change to the performance of the building, just by turning things off because the kids leave them plugged in.

It's incredible. So you mentioned that $1 billion -- I was going to ask you about that, the $1 billion business. How do we think about that growth outlook when you think about it over the next few years, yes?

It will -- we -- I think in our growth in our Investor Day, we talked about this. We anticipate that, that will be a $1 billion business within the next, I guess, probably 2 years now, 3 years of that when we said at that time. So we've got about 2 years to go, we'll definitely be above a bit. Our pipeline is in excess of that now. We learned a lot through the healthy -- if you think about what sustainable build -- we call sustainable buildings today, you go back during the early stages of the pandemic, we called it healthy buildings. That was our original focus was making the building healthy. And then we've now learned that actually building health and energy consumption are interconnected. So we've created sustainable buildings. So it will definitely be -- it's -- maybe we'll get a little bit early, but I think our call right now is within 2 years, will be $1 billion business and that we will call HBT.

Right. Well, given that it's election day, I feel like I should ask about the Inflation Reduction Act, something on actual bill that got passed in Congress. Do you think you have any impact on your business? Or how should we think about that?

Every -- I think it's a positive for our industry. I mean the establishing clarity of the investment and whether it's electric vehicles which are becoming -- which are definitely coming into the building technologies and the upgrade funds that are being made available. There's a lot of -- you talked about the built environment. There's a lot of buildings in need of upgrade in the U.S. And so IRA will definitely -- I think it also establishes some policy clarity around things like -- EV is going to really get the right number of chargers to enable the electrification of the vehicle fleet. That's now for our industry now going to drive -- we believe that EVs will become a part of the building system because the whole -- our whole vehicle economy has got to shift from fueling in between work and home and now either fueling at home or at work. So we're -- as employers, we're going to have to provision for this in our buildings, and it's actually a really complicated control problem. When you talk -- when you think about the amount of energy that now you've got to pull into the building to provision for these vehicles. So that's something that back to the IRA. That's something that -- now that there's investments being made available for those types of systems, I expect we'll see that as a benefit. So it's all upside for us.

Okay. Let's move. That's helpful. On pricing, just maybe just broadly, how is pricing faring across your businesses? Just with the backdrop of inflation. I think that's always helpful for everyone.

So over the last -- we learned a lot about pricing mechanics over the last couple of years as we went through this supply chain crisis and inflation went along with it. We've been -- we've been fortunate. Our teams have been pretty on the ball in terms of, first of all, understanding where the inflation was coming from and when because it wasn't trivial. It wasn't like that all the suppliers just called up and say, we're raising your prices by 10%. It was some of that as well as some suppliers saying, I don't have anything. So now we have to go to the broker market and buy -- we buy chips on the open market. So it's sort of that understanding inflation, and that's where our digital investments within Honeywell for internal capabilities allowed us to have maybe a little bit more presence than some of our counterparts in the industry. So we actually went -- we knew the inflation was coming. I think we've demonstrated that our technology is -- because we're a leader in our technologies, we were able to have pretty good pricing power and we were able to stay ahead of the curve. I think as we go forward, we'll run the same playbook. I think inflation will -- we expect it to be moderate this next year. So we won't have -- we won't be driving -- needed to drive the price levers as hard. But if we're wrong and the inflation continues to grow, then we'll run the same playbook. So it's been a good story, I think, for us. And across Honeywell, I think we've demonstrated our ability to kind of stay ahead of the inflation curve and we'll continue to do that.

Yes. You guys have been, across the board, have been leading on the pricing side. Maybe it's just in our remaining couple of minutes just talk margins, just you're a leading margin player in the industry. Maybe just talk about kind of your systems in place to allow you to continue to have strong margins and just any kind of long-term goals that you think about?

Well, I think the Honeywell operating system, it's really just -- it's about simple processes applied with rigor. I mean we focus diligently on making sure we have the right technology and then we manufacture it in the right place at the right cost. And I know I've been in this electronic manufacturing initiative for quite a long time. Our operations people are just really good at driving their costs out of the product. And I think the -- we run very rigorous plan. My CFO, who's here, we just had our annual operating plan first pass review with my boss yesterday as it is. And we're talking about, hey, are we -- we're now looking at our demand profile in some regions where we're looking -- some potential softness and we're building contingency plans for what cost actions we have to take to do that. And we have a very rigorous repositioning process that we -- playbook that we run when that -- when we start seeing those storm clouds. So I think we have -- I mean the foundation of why our margins are high is that our technology is better, I think, but we're also, as part of Honeywell, we have an operating system that gives us a bit of an additional edge that we just -- we are -- this company is run by general managers and we drive those margins up. And I think we've been fortunate that we've been able to sustain over the last several years that sort of steady march toward our sort of our commit that we made at the beginning of the year, mid-20s, sustained operating margins, and we'll hit that.

And then just lastly -- last minute here, may just any last minute kind of your kind of takeaway from a wrap-up of Q3, just kind of where you -- how you see the year kind of trending and I think that would be helpful.

So I think we -- I think we're in pretty good shape to deliver really solid organic sales growth this year. And I think as I look across the industry, I think we've -- whether it's through innovation or our commercial acumen, I think we've kind of led the market. I think we are starting to see, as we've talked about, some softening in demand in a couple of places that we'll keep an eye on. I don't think there's going to be anything dramatic, but I think we have to be thoughtful. We can't predict what's going to happen in Europe politically and et cetera. So we have to be cautious about how we run our playbook. I think the main dynamic in terms of our planning exercise for next year is we have -- we still -- even though we're starting to see a little bit of softening in the order profile, that's in the backdrop of a backlog that's like more than 3x what it was 2 years ago. So a lot of what we're seeing in headline -- so we went from, let's say, high teens order growth in Q2 to 3% in Q3, that would normally be kind of an alarming number. But if we actually look at the backlog mechanics, it's actually quite natural because we had huge spike in the beginning of the year. And it's just the customer -- it's like some -- it's like an inventory of order backlog that our customers are basically don't -- aren't giving us -- don't need the places -- because the supply chain is getting a little bit smoother from us and our peers, they're not giving -- our customers are not giving us 9 months or a year visibility to orders to going back to what it would be a normal pattern of sort of 3 to 6 months. So that's just going to be a natural roll-off in order of velocity. So -- that's -- it's a little bit -- it's not a linear equation. We've got to -- we can stay on top of it, but I'm not that concerned about the short-term order -- year-over-year order mechanics. I'm more concerned about making sure that we -- we actually want -- we need our backlog to come down. We're running too high right now, and we want to get that product out into the marketplace, and that's probably our main focus.

Terrific. Well, let's leave it there. That's a great way to end. So Doug, thank you so much for joining us. I appreciate it. And thanks again, everyone. Thank you.

Thank you.