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

Great. Well, good morning, everyone, and thanks very much for attending the first kind of formal day 1 of the 41st Barclays Industrial Select Conference. It's my pleasure to open here with Mr. Vimal Kapur, Chief Executive of Honeywell. I think Vimal will start off with some slides, and then we'll go through some questions. And obviously, anyone from the audience, please feel free to ask as well. That will be the opportunity in a few minutes' time. So Vimal, thanks very much.

Thank you very much, and good morning, everyone. So a few quick comments. I would say, 8 months into the role, and what I can say is that I feel confident about the strategy we are executing and how it's shaping up. There are 3 elements of the strategy, and I'm sure we're going to talk about that during our conversation. First is how we accelerate organic growth, and there are elements of that I'm focusing on -- there are 3 pillars of that, how we think about new products, how we think about monetizing installed base, and how we drive our growth in high-growth regions, and we're making good progress in each one of them. Then operating system. Honeywell always is passionate and proud of its operating system. We continue to enhance it. Historically, we focused on functional processes, like supply chain commercial excellence. And now we are pivoting more towards business model standardization, and we can talk about that. And finally, optimizing the portfolio and making the right capital allocation is big part of our priority and certainly working on how do we continue to improve the portfolio quality as part of my priority. So on that point, many of you would have seen the announcement we made on the Carrier deal, $5 billion of commitment, just shy of $5 billion. We expect to complete the deal during the course of this year, adds another leg in our Building Automation business strategy. So a great demonstration of our execution of our strategy of bolt-on acquisition. Then Quantinuum, we completed the pre-money round a few months back, got $5 billion valuation. So continues to be on the progression to make it an independent company, and we'll see how we hit the milestones, but the goal is over the next time period, we do that. And then the overall capital allocation has been an $8 billion range this year, just based on commitment we have on Carrier, it likely will be $10 billion. And we'll continue to stay active on all 4 elements of capital allocation, dividend, capital spend for our projects, share repurchases and M&A. The overall -- this is probably is my biggest focus. How do we deliver 8% to 12% EPS growth to our shareholders? And that's what I work every day, whether it is driving through segment profits, 6% to 10%, and then we add to that share repurchases and M&A accretion and then 8% to 12%, that's what has been our focus. And if you see our performance over the last few years, the top bar here is our long-term targets. And then you see our performance in '23 and '24, our commitment. They are well within the range of our commitment. So that's a punchline. We continue to make Honeywell better every day. We're making it more focused on 3 mega trends and 4 business model and delivering 8% to 12% earnings to our shareholders. With that, I'll open up to you, Julian, for questions.

Thank you, Vimal. Maybe just to dial it back to sort of the short term for a second. Maybe just give us any thoughts around kind of current demand trends. And obviously, Honeywell has vast breadth of business models and kind of short-cycle, long-cycle elements. So any thoughts on that, please?

No. As we spoke a few weeks back on our earnings call, the 2 parts of our order situation, long-cycle order remains strong. We finished Q4 with 8% up in our backlog. Short cycle, depending on the segment, they are in a different stage. We saw some segments showing recovery. We saw good bookings in our Scanning & Mobility business in quarter 4. Some parts of our chemical business recovered, and that's a gating item for this year, that how the short cycle will sequentially improve every month and every quarter, and that's going to determine 4% to 6% range of our top line growth. But I would say the strong long cycle, short cycle at trough levels and sequential improvement is what we are really watching.

Perfect. And on that organic sales growth guide of kind of 4% to 6%, if we don't see that short cycle pick up, kind of where do we end up in that range? And maybe help us understand, is the short cycle pickup dependent on comps or an improvement in base volume demand? What are some of the main things that people should be looking...

I think the big punchline, Julian, is that we are not looking for some massive inflection to get to our 4% to 6%. Just to do in the easy math for everybody, if we simply grew Aerospace by 10%, Honeywell grows 4%. So it means rest of the business doesn't grow at all, which is just a hypothetical scenario just to make my point. To your specific question, I think there are 2 factors. There are 3 important points in that. First, we are not looking for some massive inflection, some 10%. We're looking for small sequential improvement on a quarter-on-quarter basis. Why it is possible, why it's highly likely is, first, the comps are easy. We grew much higher than H1 versus H2. So we simply benefit from lower comps. Second, the [ self-help ] actions we have put in place, they scale to a certain degree and offset some risks we may carry. So all that put together give us the confidence that we're going to have a sequential improvement. And that's going to leave us in '24 at exit rate, which are going to be attractive for '25 because we are seeing sequential improvement every quarter. And that's how we are executing for the year at this point of time.

That's helpful. And if we think about Honeywell, the last 2 decades really become kind of synonymous with very strong margin execution. It feels like very short-term, the topic of investor questions is more on the revenue line. But clearly, Honeywell has a very strong kind of productivity pedigree. So maybe flesh out that a little bit more. What are you doing self-help-wise to keep the margins moving up regardless of what the top line is doing?

Yes. Look, the margin expansion in Honeywell happened through a systematic operating system. It didn't happen by brute force. It didn't happen because we cut costs randomly and hurt the business. So it has always been an and question that we want to drive operational productivity while we want to drive growth, but we -- I'll admit that our results were more impressive on the margin expansion side, while we deliver earnings growth more on the bias of margin expansion versus top line growth. Top line growth has been of the order of 5%. If I look ahead, our focus is to continue to drive organic growth, and those are the actions I'm putting in place that how we drive focus on new products, that certainly drives the baseline for any business to growth, monetizing our installed base. Our aftermarket business is $11 billion. So if that grows at 5% versus 7%, it's a meaningful difference or 10%. So how do we really maximize our offtake of aftermarket and software in our installed base is our focus. And then I mentioned before, high growth region represent nearly $9 billion of Honeywell revenue. So how we continue to do that. On the margin expansion, I also remain confident that there is a concern sometime we max out. But every year, we continue to get better at 40 to 60 basis points. Last year, it was 100 basis points. And it's not a magic. It's a constant improvization of our operating system. So if one thing, which I can say with 100% confidence, that margin expansion machine continues to get better, our operating system gets deeper, it gets more sophisticated, and we have more and more levers to drive margin expansion ahead of us for the next several years.

One element of that, I think, is the sort of Accelerator program, where you've sort of split Honeywell up into sort of 4 business models. I think sometimes people from the outside worry, is Honeywell too big, too complex to drive this kind of operational change from the top? So maybe kind of give us some perspectives on what have we seen from that Accelerator program so far.

Sure. Yes. I mean if you look at operating system, immediate thought comes in when we launched operating system in Honeywell, that was in 2005. I was still a young leader and sitting on that side of the table, embracing it. And it was really focused on supply chain. We really took on how we deploy systematic processes and supply chain. Honeywell embraced Toyota Production System as a guidepost and developed our own operating system on that. So that was under Davis' leadership. Under Davis' leadership, we substantially moved that to think about standardizing other processes, which cut across organizations. So think about sales excellence, commercial operation, like pricing, customer experience. So the question really I had was, what's the next value addition pivot for Honeywell? And the way I thought about it is that you can look at Honeywell by businesses; Aerospace, Building Automation, Industrial Automation, Energy and Sustainability. Or you can look at regardless of the segment we serve by the business model that create value. So when we look at that lens, project, services, products and software are the 4 business models, and standardizing that creates value because the value creation algorithm doesn't changes whether you do projects in buildings or energy or in industrial. And that standardization gives us, depending on the business model in case of projects, we see benefits in cash generation, a reduction of risk, so it improves margin. In case of services, we are looking at how we standardize penetrating installed base, which becomes a more of a growth vector. In case of products, we are looking at -- more looking at new product introduction, which is element of growth. So it varies depending on the business model. And more and more we practice it, my confidence of that continues to increase every time. I would say 18 months back, like any other practitioner, you start with hypothesis and you have a belief in it. Now having walked the journey, the belief is turning into a conviction because we're seeing results, and that is becoming the basis of profitable growth of Honeywell to make this machine work both on the top line and on the margin expansion and on the cash, too.

Perfect. I think one of the businesses that's proved the most volatile has been Intelligrated or Warehouse Automation. How do you see that since you've become CEO? And how should we think about any change in approach to managing it, for example?

Yes. So the good news is now the Intelligrated represents less than 4% of the Honeywell revenue. So hopefully, we get less than 4% of our questions on that moving forward, but that was on a lighter note. The way I think about the business is the value proposition of what it does is very strong. It improves productivity in a distribution center, which is key to operation of any company within the business of distribution of different products. So it's not a value proposition issue. It's how this business performs because customers are concentrated, and they make decision in sequential time. So if Walmart decides to do something, they will decide something this year, and that will plow on for 3 years. And then they don't make any decisions for a couple of years. So it's the bit of lumpiness which we are observing because there was a high volume creation in 2021, which is unwinding itself. And as it is unwinding, no new more decisions are being made. The question is, why people are not making decisions, even though we have a strong pipeline? It's a cycle of economy where many of our customers are in e-commerce, retail, logistics, post and parcels. Most of these businesses have a moderate margin rates. So the cash flows are not strong. So if they end up, the automation is hundreds of millions of dollars. So they want to match their cash flow and capital spend to a certain degree, and the timing right now is not in sync at this point of time. But I remain absolutely convicted, this is the right business for Honeywell. This was the right acquisition. If you think specifically of 2024, even if we may not grow the business until toss around in and around flat to slight shrinkage, but margins are going to expand. It's going to be an earnings accretive to Honeywell in '24, regardless of that. So what's the secret sauce there? How are we going to do that all of a sudden? This will be the first year where aftermarket will match the projects business more or less. So it continues to grow. We grew almost 15% last year. We aspire to do that again this year. So aftermarket is becoming the bigger engine of our profit pool. And then we have reduced our supply chain cost by repurposing supply chain to a more favorable cost location. So we get a fix cost leverage on that. So those 2 reasons make the profitability lesser on our challenge with '24, while the top line will depend upon how the project actions take place. And the final comment I'll make is, given the lumpiness of it, it takes 2 orders to change the equation. This business has that -- unfortunately that unpredictability, which that portion I don't like. But overall, the segment is attractive. We are well positioned. Customers love the Honeywell position in that. And long term, it will remain in mid- to high single-digit growth segment. There is no doubt about that. That's what it has done over the last 5 years. It grew too much for 2 years. And -- but if you still take a CAGR of the business from 2018 to '23, it still is high single digits. So those dimensions are not going to change.

I think one other aspect that sort of exercised a lot of people in your biggest segment in the last few years in Aerospace is around supply chain. Kind of where are we on that? And when do you think we can stop talking about that as a big [indiscernible]?

Look, the supply chain made good progress in 2023. Our volumes grew 20% and top line grew 14%, and that will continue in 2024. This segment will be constrained by supply side and not by demand side. Demand continues to be strong by OEM and aftermarket. Supply constraint remains. The good news is now, if you look at -- split the supply chain of Aero into electronics and mechanical, electronic supply chain has [ healed ]. We don't have any component constraints or supply constraints on that side. And that's a large part of the Honeywell business given our place in cockpits, systems, in avionics, radars, et cetra. The mechanical supply chain is still under healing, and that's where it has narrowed down to 3 product lines/3 areas; it's bearings, it's machining, it's costing. And That's common for entire industry. That's not a Honeywell-specific constraint. If you go to other OEMs, other supplier base, you're going to report you same 3. And then they are all linked to more or less same suppliers. So it's really the last mile of this. So how it's going to get relieved is, continue to focus on those suppliers to help them get better and develop alternate supplier to those, which takes time. Given these are certified products, you don't really have to redevelop a supply base, but recertify the product itself with the new part. So '24 will be -- my view is that '24 will be -- the supply chain will get healed to a point that the constraints, which it presents, will not remain a point of commentary from next year. But if specific to us, we have already guided double-digit growth in Aero for '24. There's no doubt in my mind that's going to happen. The supply chain actions remain robust, and we will deliver on that.

Great. And then maybe switching to capital deployment. I think you've made it clear with that kind of earnings algorithm slide earlier, 1 to 2 points of earnings growth annually from acquisition, that's maybe $100 million plus of net income, so maybe $2 billion or $3 billion a year baseline M&A spend. Is that the right way to think about it? And then you have the scope to sort of move that up if the right target comes along.

Yes. I mean as you saw, the enterprise value for Carrier is $5 billion, will aspire to -- the deal should not -- I'm not looking to do deals with a target to spend $5 billion or $10 billion a year. It's driven by the fact that we are focusing on 3 mega trends, automation, aviation and energy transition. As long as we have a right target, it makes sense to our business, we are able to compound growth, improve quality of earnings, we should do the deal because our commitment of $25 billion spend in the 3 year is the lower end of our bar. It's a floor. We have capacity in our balance sheet and through our cash generation to go all the way up to 40%. So that's the kind of a range. So if more deals come in, which make business sense, we will do it. And corollary is also true. We're not going to spend money just because we have a target. I have no target that we're going to spend money. But we have a bias that we want to improve quality of the portfolio and do M&A more actively and look for the opportunities across all segments.

And when we're looking at the sort of types of target, you mentioned that the megatrends as kind of the main areas to think about. But I guess when we think about, say, cyclicality, has the Intelligrated experience made wary of buying cyclical businesses? And maybe just characterize kind of the health of the M&A pipeline overall?

The pipeline is active in all the 4 business segments, Industrial, Buildings, Aerospace and in Energy and Sustainability Solutions. Some has more targets versus others. Fundamentally, bolt-on with an enterprise value of $1 billion to $7 billion, and they should be accretive to the growth of the core. That's the fundamental principle I look at. So if you see we acquired -- spent $700 million to acquire Compressor Control. It's accretive to HPS. We do process automation. Reliability is a big problem for our customers. So it adds capability of the business, which does that. Similarly Carrier acquisitions adds to the capability of Building Automation to add one more pillar in addition to the 2 pillars -- strong pillars we have. So that's the theme on how we are thinking about it. I would argue that giving organization clarity on 3 megatrends provides absolute north star on nature of acquisition we should be looking for because these markets are very wide and very big. And we are not really looking for discovering a theme. We already have themes, which are long term. Specific to the target apart from the objective of improving quality of our portfolio through gross margins and recurring revenue, indirectly, says that we are -- we will avoid businesses which are cyclical. I personally like businesses, which are more product business model, simple -- you ship the product and you get cash. The project business models, there's nothing to dislike it, but it is inherently more difficult. You have risk in the projects, the cash flow is choppy. And we love what we have, but likely not add more there, but add more in terms of software, services, products, which are more attainable from a cash flow perspective.

That's helpful. And when we're looking at -- you mentioned that sort of range of $25 billion to $40 billion of total cash to spend. Should we assume that Honeywell may run just with higher leverage perhaps on the balance sheet in the past or not necessarily?

No, not necessarily. We are proud of our A rating. We don't want to lose it. So the short story is that we may have an elevated level for a while, but we work with the rating agencies to show them, demonstrate them that how we're going to -- how our cash flow is going to bring our leverage back to normal, and that's the work which we constantly do with them all the time as we are doing in case of Carrier acquisition. But we -- I have no plans. My predecessors have worked too hard to get this credit rating, and I'm not going to destroy some of -- this is one of the crown jewels of Honeywell, and we'll absolutely going to protect it.

And on the sort of divestment side of the portfolio management. You've talked about the sort of up to 10% of sales. How should investors think about the -- what determines the timing of that? Would you rather buy first then sell later or they're independent? Any thoughts?

I would say that we are not -- I'm hurrying up to sell businesses at a pace. So needless to say that we will do that when there's the right valuation, but more thinking about doing it over a period of, say, 3 years. So do something every year is the model. And hopefully, the additions outpace the substraction from EBITDA perspective, may not be from a top line because sometimes we may have a top line business, we want to divest with the lower margins, but what we bring in maybe a lower top line, but that's a fundamental principle. We have identified the assets. We are putting action. I think, Quantinuum is a great example, which is in a public domain. We were -- I was very proactive about it. Since I started to say we will put a path to monetize our stake in that entity, and we're executing it. We hired new CEO. We've got pre-money rounds. The clock has started consistent to what I said. I should say, few things you have visibility, a few things you don't, but we will see progress as the year progresses on even some of the substractions we have to do apart from the additions that we are making.

Perfect, and then I think now we have to switch to the audience response survey questions. So if we could -- and I think you can press on the button hopefully, and then we'll get some results. So do you currently own the stock, overweight, marketweight, underweight or not at all. Then, okay -- so a lot of people to be -- one over there. Next question, please. What is your general bias towards Honeywell's share price right now? Positive, negative or neutral? So fairly neutral, 70%. The next question. How will it's through cycle earnings growth rank versus, say, broad multi-industry peers above in line or below? So in line about 60%. The next question. What should Honeywell do with excess cash? There's a long list of alternatives so we could -- we can start with that. So it's a hodgepodge -- internal investment, the main one and then noninternal would be bigger buybacks, let's say, and the dividend seems satisfactory the most. The next question, number 5. What multiple of current year earnings should it trade at? Shouldn't be much in 1, 2 or 3, but let's see. So the most popular answer is sort of around 20x. So maybe a market multiple or a slight premium. Question number 6. What's the most significant kind of headwind? Why is most of the audience neutral on it or not [ owners ], growth margins, capital deployment or strategy? So mostly core growth. It goes back to a lot of what we've been discussing. Next question, please. I think that's -- yes. That's the main wrap of it. So I think...

I wish our politicians get to do that, right? I'll try it next time.

No. So I think there's a couple of things. I think one is on core growth. Yes, I think, Vimal, this has come up in conversations around you, does Honeywell focus, I don't know how to put it, too much on margin? Is there a need for catch-up investment? That discussion comes up again and again. Any thoughts you'd give? And also the point around, is the portfolio too broad? So there's always something going down, offsetting something else, getting better. There are 2 different questions, but they both go back to that point on core growth.

Yes. I think that the Honeywell portfolio was impacted both on the entry and exit of COVID on either side of it. When we entered the COVID, we were impacted in Aerospace and Energy. They were probably the -- 3 worst segments were Travel, Aero and Energy, and we had 2 out of 3. So that was 2021 picture. And we took much longer to unwind given nature of the supply chain we have and distributor stocking. We talked about Intelligrated, so it rose a lot in unwinding. So I think we were a little bit dispositioned with the portfolio. But the good news is that's behind us. All the COVID noise up and down is behind us. I find this year as more normal as the short cycle recovery happened in the second year. And the organic actions we are putting, I have no doubt in my mind that we are going to deliver on our organic growth. This is not if. This is a cyclicality, which we dealt with due to COVID, and we're going to deliver performance on the strength of our organic action. I want to make sure that everybody -- nobody carries impression that we put underweight on growth action. This is where I spend my time, and this is where we will spend our -- we are spending our dollars. So -- and I know we have to deliver results, and we will as we have guided for this year.

And do you feel on that complexity point, it's been 8 months in the CEO job. Do you find the organization kind of sufficiently responsive?

Absolutely, I think organization likes, and I think most of our customers and shareholder likes clarity on 3 megatrends. I think it makes Honeywell simpler to understand. And that provides us a north star on what Honeywell we are building for the times ahead. It's easier to consume, but also easier to understand, and organization is excited on the simplification. And my past history, having run multiple segments in Honeywell, when you have the segment clarity, I was leader for Process Automation for about 4 years and Building Automation for about 3 years, single segment, very clear purpose, you execute, you get results. But when you have a little bit complex segment, fragmented, lack of clarity, you do not get the long-term flywheel impact of it. And I'm a big believer of that, and that's why we did the simplification of Honeywell.

And last question, for those who might say the solution to the core growth question is disaggregate breakup, what have you -- what would you say in response?

I would say that, look, my goal is -- my job is to deliver 8% to 12% earnings growth. We are putting actions to deliver that by running Honeywell as an integrated operating company. We are proud of our operating system, it creates value. But if any situation comes, which I do with the Board every year, to look at optionality, does the breakup is a superior option versus being together, we'll absolutely look at it. But current focus is to run it effectively and generate the earnings growth.

Perfect. Thanks very much. Thank you, Vimal.

Thank you very much. Thank you, Julian. I appreciate that. Thanks.