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

Good morning, everyone. My name is Sheila Kahyaoglu, the Jefferies aerospace defense and airlines equity research team. Thank you so much for joining us at our conference and for the Honeywell team to be joining us, always the first slot. We really appreciate it. We have Jim Currier here, who's President and CEO of Aerospace Technologies; and Mike Stepniak here, who's CFO of Aerospace Technologies. And if you didn't see the announcement, Mike got promoted this morning to CFO of Honeywell Aerospace -- Honeywell overall. So thank you, Jim, for being here. And thank you, Mike. And thank you, Sean, for coordinating this and making it happen. So really appreciate the opportunity to cover Honeywell over the last 12 years, and Aerospace is obviously my favorite sector so -- segment.

Jim, maybe if you could just start. Aerospace has been a leader within broader Honeywell, really driving revenue growth as well as earnings growth with all three end markets up double digits in Q2 and margins above 27%. How do you balance the second half just in terms of order trends and expectations for factory output?

So I think one thing I would say is we did have a very strong first half of the year. We target very heavily our supply chain output. And what we've targeted for the second half of the year is to be at mid-double-digit going into the second half. And when I break down that mid-double digit growth occurring in the second half of the year, I think about it along three parallels. I think about Commercial OE, Commercial Aftermarket and our Defense & Space. And our Commercial OE business is continuing to grow very strongly in support of that. And then the Aftermarket is still growing in levels that we like to see, although I would say it's starting to normalize a little bit more across the board. But the one element, I think, for us has been exceptionally positive has been our Defense & Space business overall as well. We spent a significant amount of time over the last 18 months really focusing in on that sector and the opportunity that exists there. We've done a significant amount of investment in that space as well in terms of supply chain output and capability. And along with that, with the strong first half we've had in Defense & Space and what I anticipate will be continued second half strength in Defense & Space, I would say on a full year basis, our Defense & Space business will be up double digit.

That's great. And we'll get into some of the comments you just made. So -- but let's start off with Commercial OE. You said Commercial OE is still continuing to be strong, but it's hard not to touch upon the supply chain. Although yesterday, at the conference, it was less of a topic than I expected it to be. Your output increased 14% in the second quarter. Where does output need to be to migrate to demand? And what part of the Aerospace portfolio has been most impacted?

So what I would say is in terms of output to meet the demand, again, it kind of goes back to what I was saying earlier about ensuring that we're hitting our supply chain output at that mid-double digits for the balance of the year. And if we can continue that going forward through 2025, which we are set up to be able to do that, I would expect to see towards the end of '25 to see a little bit more of a normalization in terms of supply chain and supply chain output with respect to the demand across the board. So that's sort of where we've been targeting. Now I will tell you when I tend to look at supply chain within Honeywell Aerospace, as I've indicated -- or I've mentioned before, we've got a very broad breadth of portfolio. And I tend to bifurcate our supply chain into our electronics portion of our business versus the mechanical portion our business. And over the last year, I would tell you that our recovery on the electronics side of the business has done quite well to the point that I think we're nearly recovered, where we need to be. The struggles have continued to be on the mechanical side, although dramatically improving over the last 12 months, but we still have a lot of work to do there. And the fundamental underliers in terms of what's holding back some of that recovery in the mechanical is very different than the electronics portion of our business, and it's really labor constraint. That continues to exist across the industry and across our industrial supply base. But we are seeing dramatic improvements relative to that. And again, continuing with that mid-double-digit growth in terms of supply chain output throughout 2025, we expect it to be certainly more normalized at the end of '25.

Maybe on that mechanical versus electronics, just a follow-up there. What's the split of parts versus labor? And where do you see the most labor constraints? Is it regionally or...

Yes. I would say it's more regionally here within the U.S. I mean, it's a very fragmented supply base within the mechanical world. There's a lot of smaller operations that are existing there. And coming out of COVID, there was a large, large output of missing labor, labor that left our industry as a result of that. I would also say it's highly specialized in a couple of areas. Castings, forgings and bearings, in particular, are an element and an area for which have provided a lot of constraint in our industry.

Great. Some of those guys are here, so maybe we could follow up with them. And then just maybe keeping with the OE, what are you seeing in the market today? I mean, it's a question we get very often, given volatility in Boeing's production rates. What are you operating at perhaps across your different platforms? And how do you think about that output progressing throughout the year?

Yes. So granted, there's been some volatility with Boeing production demand. A little bit with Airbus, not nearly as much as what's been occurring with Boeing. What I will say is that we stay very, very close with both organizations in terms of production outputs and production forecast and ramping that is necessary. There's always a concern that's out there about what's going to happen in terms of destocking and/or if there's an acceleration in terms of production, does that become an issue for us going forward. And I would tell you, it's not. I'm not concerned about that. For us within Honeywell Aero, the demand is very strong across the board. And again, staying very, very intimately tied up with both of those organizations and their plans has allowed us to stay in sync with what they're planning on doing going forward.

Any numbers you could give us on where you are on the MAX and the -87 perhaps?

In terms of?

Production per month.

I mean, we're still continuing to deliver at the rates that are necessary and as required by both organizations.

Any thoughts on where you're capacitized for in terms of labor?

I mean, as we think about the long-term horizon for both of those organizations and their production needs and our continued ramp in investment, we're going to be able to support their needs going forward.

Got it. And let's talk about bizjet. I think most people forget that Honeywell has a spectacular business jet business both on the avionics and engine side. Maybe if you could remind folks how much it represents? And how does -- how are you thinking about growth rates in that business and potential share of this?

We continue to see strong growth in the business aviation market segment. I mean, we do have strong positions relative to our products and portfolios across the industry, in particular. I would tend to look at a little bit along the lines of we think about our content that we have with Gulfstream as an example, new platforms that are coming out with Gulfstream. The G700 has just been certified. You have the 400 first flight that recently occurred. G800 is on the horizon as well. Across those aircraft platforms, our content consists of avionics, APU, environmental control, cabin pressurization control. So we're very proliferated with our portfolio across those platforms, and those are going to be very much growing platforms for the future. The other thing I would say within business aviation is the super midsized segment. That's a very strong segment within the business aviation marketplace, and we're well positioned with the OEMs and our HTF engine in support of that segment. And with the rates and the production growth that is occurring there, what it sets us up for, ultimately, is to have more engines in the field, which drives that long-tail aftermarket revenue stream for us. So we're still very excited about what business aviation affords to us and what our positioning is in that segment.

Can you remind folks what you do on the 700 and the 800 and in the 400?

In terms of content?

Yes.

Yes. So it's going to be avionics -- full suite avionics. It will be auxiliary power units, cabin pressurization control, environmental control as well.

Great. And then maybe on the ATR side, can you touch upon your ATR exposure -- Air Transport?

In Air Transport, I mean, we're well positioned across narrow-body and wide-body, both on MAX and both on neo platforms going forward. Both strong in terms of avionics and mechanical content.

Sorry, I meant regionals. I apologize, I know the verbiage is always different.

Sorry.

No, no, it's okay. Transitioning to the Aftermarket. You made some comments earlier about Aftermarket continuing to grow. We've been very bullish on the Aftermarket. So maybe if you could give us your thoughts on the 17% growth you saw in Q2? Where you see some runway versus where you're maybe seeing some potential slowness?

So kind of similar to what we have on the OE side in terms of how we target our R&O growth in terms of aftermarket. Again, it's in that mid-double-digit range in terms of output growth. Again, very similarly to the OE side in terms of recovery in term -- with the product portfolios and the supply chain, more recovered on electronics versus the mechanical portion of the portfolio. We still continue to see a lot of unlock happening there as well. So we're still very excited about what the Aftermarket represents for us not only in the air transport market, but what I alluded to a moment ago, in business aviation with the HTF engines entering the market at the rates that they're entering today. And the other thing I would say in Defense & Space. Our Defense & Space aftermarket R&O business has been doing exceptionally well.

Sticking to the Commercial Aftermarket, what percentage of your sales is locked in through service agreements? And maybe if you could talk about what those service agreements entail? And what percentage is book and ship?

Yes. So we don't tend to break it down to that level of detail in terms of the Aftermarket and how we support that. But when you think about our maintenance service agreements or our maintenance service plans, it's exactly what you would refer to it as: it's powered by the hour essentially. So for every flight hour that has flown, there's a revenue stream that comes off of that as a result of those maintenance plans.

Can you give us any further exposure, whether it's different types of aircraft? Are you more of those on the narrow-bodies, wide-bodies, anything you could parse out?

Yes. I think what I would say relative to that is when you think about the air transport market, in particular, as you're mentioning narrow-body and wide-body there for a moment, the number of what I call classics of the narrow-body that are out there are about a 3:1 ratio versus the new aircraft that are entering the marketplace. And so when you think about it in that context and you think also that production rates are still continuing to ramp in OE and have been a little bit slow in being able to do that, you think about it as well the number of aircraft that have been grounded due to engine-related issues that have been occurring across the industry, that continues to drive a substantial amount of those classic aircraft to be flying for which we've got a significant amount of content on board those aircraft. And I anticipate that to go forward for quite some time for us to support us. And then when we think about new production, we've stayed very, very closely at the rates of production between Airbus and Boeing as well and the volume or the ratio, I should say, between those going forward. But again, I would say our content on both of those platforms is very strong. And ultimately, with those aircraft that are entering the fleet, getting into production, it sets us up very nicely for continued Aftermarket growth.

Maybe as you think about -- remind folks what your 2024 guidance is for Commercial Aftermarket? And then how do you plan for 2025 growth? How does your team internally come up with that figure?

So we -- in terms of Commercial OE side of it, obviously we look at the production rates that are occurring across the board that drives our forecast, for financials relative to that. And in terms of the Aftermarket, there's obviously a multitude of variables that we look at. One of the primary factors is content that we have on aircraft, number of aircraft that are flying, flight hours that are occurring globally, both domestically, internationally, combined narrow-body, wide-body. Our content on wide-body aircraft when you think about the dollars per hour is about a 3:1 ratio as well in terms of number of flight hours and the revenue stream that comes off of that as well. So we look all of those factors come into play as we look about where we're going to see ourselves for next year.

And in terms of that, just if you could maybe give us any thoughts on utilization of aircraft. We have the luxury of covering airlines in the U.S. and we've seen capacity come in even month-over-month. We're seeing about 1 point of come out of the U.S. market. Do you see that impacting your Aftermarket revenue streams at all? And any thoughts on domestic versus international trends?

I don't see it impacting us. I don't think it's material what I've been seeing in terms of capacity adjustments that are occurring in the marketplace. Again, I think, largely driven, if you think about the breadth of our portfolio and the end markets that we serve across the board, that is one revenue stream into the overall Honeywell Aerospace Technologies portfolio, and ultimately, our growth that occurs. So yes, even though there is some adjustments that are occurring there, it's not material to what we have ongoing going forward.

And then maybe one more on the Aftermarket. So as we think about 2025 because I'm a big bull in the Aftermarket, what would you say is the best way for financial analysts to kind of think about the growth rates there?

Yes. I think I would take in consideration not only what's occurring in the commercial space, but also in the defense space as well. And that's where we're seeing a lot of growth happening. The one thing I would say relative to that, it's been years and years of, what I would say, lack of investment either from DoD or international allies in terms of supporting their existing equipment that exist out there today. And as a result with some of the geopolitical conflicts that are recurring around the world, there's a substantial amount of investment that is occurring to bring those aircraft, fixed wing and rotary wing, back to operational status as well as building up on munitions as well, which we have strong positions with our portfolio. So that's another element that will be driving some of our growth going forward.

And maybe if you could talk about price. How does price play into your Aftermarket growth? How do you do price increases? How do we think about pricing since 2020?

Yes. So our price algorithm has been set up such that -- and it's been a great enabler for us that has allowed us to stay in front of the cost inflation curve. Now as you also know, a lot of our price is tied to our contracts that we have with OEMs, with fixed indices that occur both on material and on the labor side. So there is some constraint relative to what you can do there. But then pivoting to your comment a moment ago about how does it play into the Aftermarket and then the overall picture for Honeywell through our catalog pricing that we have, which drives spares pricing and R&O pricing for us going forward, we've been able to get a little bit more leverage out of that, that helps to help offset some of what we're seeing on the OE side and we'll continue to see that going forward.

A few more price questions. How do you think about price since 2020? How much has price been -- on a gross basis been helpful?

From 2020, I mean, it's part of the algorithm that we have going forward. I mean, in terms of absolute percentages, I would say it's been staying in front of that -- like I mentioned, in front of the cost inflation curve that we've had.

And is it -- given the algorithm, how does it work? Is it on the catalog that updates frequently? Or do we see old school price increases at the start of the year, every 6 months? How does that happen?

No. We adjust it on a little bit more of a frequent basis because of the dynamics that have been happening within the industry itself as well and some of the changes that have been happening in terms of inflation that have occurring over couple of years. So it is a bit more dynamic than usual. But again, it's part of that price algorithm curve that we have.

And maybe if you could talk about has the algorithm changed in any way as you think about raw material prices fluctuating a lot more since the pandemic? Are there things that you should watch? And are there different elements that -- this was a theme that came up yesterday as well on how different raw materials have really fluctuated in aerospace and the market has to be more dynamic.

Yes. And that's exactly we tend to be a little bit more dynamic in terms of our catalog pricing going forward is to accommodate and to adjust accordingly for dynamics that are happening in terms of material pricing.

Anything to watch? Any raw materials in particular?

I think specialty materials is what I'd be a little bit more concerned about going forward. In our industry, there's a lot of specialty material that is used in support of the products that are used in our industry. That's an area -- I would say that's an area to stay very focused on. One thing that we've been doing is we've actually been buying material in bulk for specialty material to support us going forward and on behalf of many of our suppliers as well to help maintain some of that supply chain resilience and robustness on a go-forward basis because that is an area of concern. And the one area in particular that I would say is of concern, I mentioned it a moment ago, is bearings. Bearings in our industry are a constraint that we have. And in particular, it goes all the way down to the raw material that you use for high specialty bearings in the aerospace industry.

That's super helpful. Let's talk about Defense & Space a little bit. You talked about the inflection. Remind folks of the growth, because I don't know it off the top of my head, that you've seen this year and how you expect to trend going forward.

Yes. So for us, given the strong first half of the year that we've had in our Defense & Space business and what we anticipate for the second half, we will be double-digit growth year-on-year in Defense & Space. And going forward, I anticipate that to continue. On a long-term basis, it'd probably be mid-single digits, but in the short term here going forward, due to the significant amount of orders that we have and the significant amount of demand coming out of the Defense & Space element, it will be high single to maybe low double going forward as well. A very, very strong segment for us. And I think it's also indicative of where we've been focusing some of our attention in regards to capital deployment, capital allocation, some of the recent acquisitions that we have done that have been very defense-centric have been actually an enabler to continue driving that growth for us going forward. And again, it kind of goes back to what I was mentioning a moment ago, there's been a lack of investment globally in the defense sector. And now there's a restock piling and a reinvestment occurring around the world to address some of the geopolitical concerns that are occurring, and that's driving a substantial amount of demand into our portfolio.

I'll get into the investment that you guys have made in Defense. But first, I want to go back to the double-digit growth and sustaining mid-single digits. What do you think has driven that double-digit growth? Maybe if you could parse your Defense exposure with domestic versus international. What's been helpful from international versus outlays kind of the floodgates opening up there?

Yes. A couple of things that I would say. So we've got great exposure in terms of content on a couple of very key platforms that are growing and driven largely by some foreign military sales. And the example I would give there is going to be on the Chinook where we have our T55 engine. There's been a substantial amount of growth occurring in foreign military sales. And so hence, the demand for our T55 engine is growing as a result of that occurring. The other thing that I would say is F-35, we've got a substantial content across the board on F-35 as well. And again, that's another platform that is growing. It has a significant amount of foreign military sales associated with it. So that's been a great enabler for us in that regard. And the third element that I would say in terms of our Defense & Space business is really around our inertials and navigational equipment. That is another area that there's been substantially very strong demand that has been occurring in that space and another opportunity for our growth in Defense & Space.

Got it. So it's been more content based than -- internationally based rather than supply chain -- a little bit of supply chain alleviating, I guess, and...

Yes. No, some of it is supply chain alleviating. I mean, I mentioned a moment ago some of the investments that we are doing and the investments that we're doing in the supply base. And some of that has been honed in very, very specifically around the needs for the defense and space industry. And so unlocking that portion of the supply base has been an enabler for some of that growth that's occurring. But that growth is also occurring because of the demand that's coming in because of our positioning on these platforms.

What has that defense investment been? Does that mean you send Honeywell folks up to smaller suppliers? Does that mean you buy them? Does that mean you build the production lines in yourself?

Yes. So I mean, across the board in terms of supply chain, and I'll talk a little bit specifically in that area that you're mentioning, we're reevaluating everything that we're doing, right, in terms of whether we're in-sourcing, multi-sourcing, dual sourcing, bringing things back into the U.S. to address some geopolitical concerns that may be out there, ensuring we've got robust and resilient supply chain going forward. Getting to some of the specificity. Does it involve us sending people into suppliers? Absolutely. And we've done that in a large measure with many of our suppliers across the board. Does that mean going in and buying material on behalf of suppliers? Absolutely. We've been doing that as well, where we could buy up a year's worth of material to support them on a go-forward basis, an investment that maybe they could not have made because in the mechanical space, as I mentioned, there's a lot of smaller operations that occur out there. Does it mean buying capital equipment on their behalf? Absolutely. Buying additional capital equipment for ourselves? Absolutely. So it's across the board, whether it's labor, whether it's material and whether it's investments on CapEx as well.

You know what question I'm going to ask next because you [ baited ] me here. What does CapEx as a percentage of sales look like for -- maybe Mike should be answering this, but he's off the hook today because he has another job. How do we think about CapEx as a percentage of sales for Aerospace and working capital on a normalized basis and conversion for the sector versus these investments? How does that change that potentially?

Yes. I think what you're going to see is you're going to see an increase in our capital expenditures going forward relative to that. And again, it's really around rebuilding some of the industrial supply base that we have.

In terms of just -- let's talk about the capital deployment Aerospace has done. You guys have been actually quite active in the capital allocation space in terms of deals. You just closed a deal, I think, yesterday, Savanti, right? Was it yesterday?

It was Civitanavi, it was a week ago. And CAES was last Friday.

Okay. Sorry. I can't keep up. So maybe give us an update on CAES because it was quite a big acquisition, $1.9 billion. What made you attracted to the asset? How does it fit into the [ pool ]? And then if you could expand on...

Yes. So it has been a very exciting last 9 months or so, right? And to your point, we have become much more acquisitive in the aerospace sector within Honeywell with those two companies that you mentioned, Civitanavi and CAES, CAES being obviously the larger of the two and which closed on Friday. When I think about capital all in terms of an acquisition, there are certain things that we look at within Honeywell Aerospace that identity whether or not a particular property or a particular target is going to fit well with us. Areas that I tend to focus in on are technological advancements in areas of high-growth region. So if it's a technology and a property that's got positions on aircraft platforms, fixed wing, rotary wing, land, sea that's maybe growing at high singles, where is there an opportunity with some of our synergies that we bring to the equation with the property that take those high singles into like mid doubles as a result. So we look at technology, the positioning and then the synergies that we bring that becomes a multiplier on their current growth algorithm that they have. That's one element of it. The second piece that we look at is in terms of their manufacturing capability. We look at the people. We look at the growth algorithms that they have. If you fit into all of those equations, then the company becomes very attractive to us. Then we look at the technologies moment, electromechanical, next-gen propulsion systems, alternative navigation, autonomy, avionics, sensors. Across our entire portfolio, we're very active in looking at properties. Now specifically to CAES, which was your original question here, right? I laid the backdrop because when I think of CAES, they checked all of those boxes for us when we look at properties that are of interest to us going forward: advanced technological solutions in terms of advanced radar and electromagnetic defensive solutions, space RF capability, advanced mechanical capability, advanced manufacturing -- state-of-the-art manufacturing capability. Growing a space of high singles that through our synergies and taking them more into the international market, we can take that into mid doubles going forward for them as well. The engineering talent is an incredible aspect of it. You can't grow our businesses and think that just organically you're going to be bringing in engineering talent. The talent in CAES is exceptional, and so bringing them into the fold and being able to utilize some of that talent on some of our other portfolios is another element of interest. So as you can see, as I describe what CAES brings with the 2,200 employees that they have and the products and the portfolios, it's checking all of those boxes in areas that we are very much part of our growth algorithm and what's of interest to us. And the last thing I would say that is super important is culture. The culture of a company that you are acquiring has to match the culture of your company as well. There's no better way to destroy the value of a company than thinking that the culture clashes are going to survive because they won't. And they're very mission-centric focused, they're very customer-centric focused, and that aligns very specifically with how we operate Honeywell Aerospace Technologies. It's all around the mission. It's all around the customer. And we looked at that culture and we said there was a great cultural fit as well between the two companies.

That makes sense. Maybe if you could talk about all the investments you're making, whether it's products like Anthem and when's the launch of that? And how you think about UAM longer term?

Yes. So in terms of investment, I mean, the one thing I would say is in this environment that we're operating in today, there's no greater time to be investing into our portfolio for the future. And again, if I think about the broad breadth of our portfolio, I can honestly say there's not a single segment of our portfolio that we are not investing in today. Now you mentioned specifically Anthem. There's other things that we do in terms of next-gen propulsion systems. There are things that we do in short cycle. So part of that is really finding the -- striking the right balance between investing in short-cycle opportunities as well as long-cycle opportunities. And I think one of the things that we do very well because of our large installed base is the fact that it creates opportunities for retrofit, mods and upgrades or what we refer to as RMUs or decoupled growth. So we do a lot of investment in that area as well. And we invest anywhere between 5% to 8% of our total revenue in terms of investment that we're putting into Aerospace Technologies across the board. Now with Anthem, in particular, the one thing I'm really excited about that is the way we've architected that system going forward, it can be utilized on a multitude of different platforms. It's not bespoke for a particular end market. And right now, we've had a lot of successes in terms of selections in the advanced air mobility market segment. But I can also tell you there's a couple of unannounced programs that we can't speak about in business aviation. And we're in very advanced conversations with another OEM in terms of incorporating Anthem into their portfolio as well. So we're very excited about the offering that it brings to the table.

That unannounced gets me excited on bizjets because it's great to see that there's continued investment happening in that end market. And that 5% to 8%, just to clarify, that's all company funded?

Yes.

Oh, wow. So that brings me to one of my last questions in terms of profitability, wrapping it all together, margins have been running ahead of plan and continue to do so. How do you think about profitability as we head into the second half, given CAES mix? And how do we get to that 29% operating margin goal?

Yes. So we are in a heavy OEM growth cycle. We are in a heavy investment cycle, as I mentioned a moment ago in terms of the investments that we're doing into the portfolio. And obviously, we have the acquisitions that are occurring as well. So there's a lot of dynamics that are in play. And I still would expect us on a short-term horizon to sort of be in that flattish range. But I think as I was talking about a moment ago, we've got the playbook and we've got the algorithm that on a longer-term horizon I see us within reach of getting to the 29%, which is something we've been talking about longer term. Short term, that we've got a lot of these investments that are occurring and we're seed planting that for the future. And our margins, I think, will evolve a little bit over time as we continue to do those investments and acquisitions.

Great. Well, thank you so much, Jim, for doing this. And thank you, Honeywell, for participating. Appreciate it.

Thank you so much for your time. Thank you.