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

Well, thank you, everybody, for being here. I'm super excited to be here. And no better way to kick off the 12th Annual Laguna Conference then with Vimal Kapur, Chairman and CEO of Honeywell, the largest U.S. industrial company by market cap. So you've been in the CEO role now for a bit over a year.

So I guess where do you think Honeywell stands today and looking back over the last year, what have been the biggest challenges for you in the role? And what do you think have been the biggest successes for Honeywell over the last year plus?

So thanks, Chris, for getting me. It's my year 2 to this conference and we were debating it's the same hotel or a different hotel. I and Sean have not concluded that argument, but it's good to be back. And last day when I came here, I was early days into my job. And I would say that I was more in the strategy formation stage. No, I can say confidently, we are more in the strategy execution phase. And if I reflect back, my fundamental thesis was twofold. The first is the Honeywell portfolio need some active management if we have to be growth oriented because we have set up some excellent assets, but we also had a few things which dragged us. And at the same time, we are missing some opportunities so if we do not do active management of the portfolio, we are going to not make progress on expectations, which our shareholders have. And the second learning was that we really don't have one consistent business model across Honeywell. What is Honeywell business model, okay? We have 4 segments and every segment know how to make money but there has been no consistent theme. So I made a choice that Honeywell business model is all about creating installed base and monetizing installed base. We largely do that but doing that consistently, to me is a set of opportunity. And when I say monetizing installed base software fits in right there because you can monetize the services more so in today's world with connected services, software and I took on those 2 fundamental principles to say, we need more active work on portfolio. We need more active work on business model transformation and then took on that journey from execution from that point onwards. And one year down the line, I would say the portfolio work has made progress. We made several acquisitions across all the 3 segments. One of the other thing I did was I should have added in my comments is I said I want to just limit Honeywell to 3 mega trends aerospace automation and energy transition. It's too wide a company. It's hard to understand. Let's make it simple. And then on the progress on the 2 items, essentially on M&A, many would have observed, we have made several acquisitions. They're all either in aerospace or in automation or in energy transition. So we are extremely disciplined now to what we stated. On the exit side, we're doing work, we have been quiet about it in the best interest of our shareholders. I can only share that a lot of work is being done, and I'll be personally very disappointed if we don't demonstrate progress in 2024, a meaningful progress, not on the edges and say, okay, this seems like a check in the box. I do expect to make progress on that. So I think on the portfolio front, we have activated the wheel and I do feel now we have the right trajectory. We need to keep on it. I want to make portfolio management as an active part of my tenure in Honeywell. On the business model side, again, we have done a lot of work to run Honeywell with this 4 business model, project services, products and software and really develop a culture that a business model is for growth. Because business model, the moment you think it, you always think about it's a cost takeout model. That's how we all grew up with Lean and Six Sigma and those tools. But we are challenging the notion that we can have a business model for growth. And we are putting that at each segment level to make sure that we have this whole culture of great installed base, monetize installed base. And we're making progress on that. I would say more in the middle innings versus the later innings, but we're making progress. On your question on disappointments, I would say, I'm typically a restless person, so speed of execution is -- could be better. But also I recognize that it's a company with 95,000 people and operations in like 20 major countries. So things are not want to move at my pace. We have to take the organization along with us, change the mindset of the culture. So speed and I would also recognize that I'm personally disappointed on how the stock has performed over 1 year. It's been flat. $200 give and take. And obviously, we fully understand we need more work to demonstrate growth across all 4 segments. So those are 2, I would say, more of a disappointment. But I feel confident in the progress we are making and the direction we are headed for.

Yes. No, I appreciate that. And as you try to return Honeywell or make it a more growth-oriented company, you've listed delivering organic growth on the upper end of 4% to 7% as your #1 priority. Certainly, end markets getting better help that. But when you think about what the company can do, whether it's the active management of the portfolio, whether it's maybe more investment into the business lines. How would you think about the active piece versus the more organic investments to get growth going?

So to me, the growth is -- first of all, I do believe that when we said 4% to 7% and upper end of it, not many industrial companies have done that for a long time, and Honeywell also hasn't done for a long time. So I'm a bit being contrary into our own history. Now for the last few years, we have demonstrated 5% growth. This year, we have forecasted 5% to 6% last year was 5%. So we have been in that ZIP code. The question is, no one can counterargue to say that's because of Aero. The point is if my -- if our portfolio is generally like Aero, we don't have to say it's because of one segment, and that's why the portfolio becomes more imminent. I see 4 drivers of growth. If we have to grow on the upper end of 4% to 7%, 4 thing needs to be true. The portfolio has to be right. Business model has to work. We need to be pointed to the right verticals in our portfolio. Having a good portfolio, like in building automation, what 100% of our business was in real estate, right? I mean the answer is wrong answer, good portfolio, bad place. So we also need to be pivot to the right verticals and finally, we need to have the right new products, which make us compete and take share in the market. I take the sum of all 4 in the businesses where we do this well, we can take the growth of Aerospace for granted. We are growing at high double digit for several quarters. It's not only the market demand and supply execution we are doing, but also the business. If you really look at are they positioned at the portfolio is great. It's a nose-to-tail business model, quite unique because not many people practice that. They really monetize their installed base. They are pointed to right verticals to move it maybe aggressively to defense as opportunities coming up, and their new product portfolio is impressive. So the growth is occurring because they're doing this. And when you don't do that and some other segment, our challenges are like in industrial automation, our portfolio is not growth oriented in some portions. We are having headwinds on the end markets or we are not positioned in the right verticals, even though we have the right portfolio. So to me, fixing the fundamentals but if I look ahead, I'm sure many people are curious going to happen in 2025, even though we want to keep discussion long term. I think the setup is good because exit Q4, all the 4 businesses will grow after a very long time. I think it looks like a distant memory even Honeywell did that, but we are going to do that in Q4. We have good backlog would set up for that. And 2025, that trend will continue. Now it will be variability, there will be still an upper end and others may be in the other side of it but it's going to have this early demonstration of the dialogue I'm having and Honeywell is becoming a growth-oriented company. All segments are growing. It's nice to have a debate. Now why this grow 4, it could have grown 6. Okay, that's a nice debate to have. but we will be posturing to another good growth year coming ahead for us in 2025.

Yes. No, I appreciate that. And when I look at growth versus the peer group over the last 3 or 4 years, the growth has been a bit softer, but margin expansion has been kind of the other side of that and you've -- earnings and operating profit has stayed good on the margin side. I guess, how do you balance the two? Because it feels like on some level, driving growth could be -- have negative implications for margins or a bit of a headwind if it requires investment.

I mean I think whatever we have learned over the last since COVID is that we have really learned how to do balance between price and volume. And 2021, we forget the history very quickly, the whole inflation when it occurred. '22 we really pivoted heavily towards pricing, and our pricing was in high singles, some businesses, even 10%. And that delivered excellent margin expansion for 2 years in a row but we are conscious of the fact, what work we have done over the last -- specifically in 2024 is much deeper understanding of price elasticity where there's an opportunity of volume versus price, we were a hammer in '22 because we are protecting Honeywell's margins. I mean there was no other options. So Darius did the right thing by pushing it hard. But now we are becoming more sophisticated. And interestingly, during '24 the inflation dynamics have become so variable in the planet that having a universal pricing strategy is no more a game. I mean, other than China in August and there's nothing the word inflation doesn't exist. The world is called deflation there. So how are you going to raise price there? I mean you have to think about how much cost I can reduce and how much volume I can gain. And if you do not know that accretion, you will keep losing share because domestic companies are doing that. U.S. inflation, we still continue to observe 3% to 4% range. Europe, it's somewhere in the middle. So to me, the balance is going to be all about we get a growth in a balanced way, both from price and volume. And this year is a demonstration of that. I mean we're going to get price around 3%. That's what we had forecasted. Volume will be 2% to 3%. I would expect that, that will be a generic model moving ahead. I mean, I can't give you a number for '25 but it will be the similar ZIP code if we have to look ahead for the next few years.

I appreciate that. And Q2 was maybe a little bit opposite of what we saw in the prior quarters. The growth picked up, but then the margins kind of stagnated a bit. And when I look at the guide for the back half of the year, it's calling for growth to continue to increase in margins kind of more in the sideways range. Is that what investors should expect as you kind of try to turn back on the growth?

Not at all. I would say, Chris, what's -- it's just a dynamic of within the portfolio, what's growing. And the growth is occurring more on the longer-cycle projects businesses and less growth is occurring relative to that on short-cycle product businesses. And the gap difference on margin between them depending on our segment could be anywhere from 20% to 30%. So every segment margin is expanding in Honeywell. We have a great year in direct material productivity, historic high we are seeing productivity in our supply chain operations as volumes are coming up. So there's no margin issue. It's a math. Like in case of Aerospace, the OE growth is continued to outpace aftermarket and which is headwind for margin, good news for installed base creation. Similarly, in building automation, the projects business have grown far greater in double digit versus product business, which is more flattish. It's simply -- it's a calculator. They just say, this is an input output wants to be this. I won't read too much into it. I would say that our algorithm of 40 to 60 basis point of margin expansion absolutely protected. But we need to view that on a horizon. We did 190, 2 years in a row. So we have delivered essentially 4 years of margin expansion in 2 years. Should we continue to ramp on it. I like to, but I think we are also conscious on volume growth. So it's a situation. I think how it's evolving. We probably -- I don't want to read too much into it, very frankly because every business margin expanding, VCM expanding and we're managing fixed cost, that's what I really hold our GMs accountable for. And if the economy is driving outcome in a different way, this is something which we can't control, and we just need to respect that.

Yes. No. Maybe moving over to the portfolio. The company has a lot of dry powder. $25 billion plus was highlighted in 2023. You guys have done maybe $10 million of deals. But a lot is left. You guys have been pretty clear that the focus is bolt-ons, $1 billion or $7 billion, big deals for most companies, but bolt-ons for Honeywell. I guess my question is, why do you guys believe that smaller bolt-ons are better than maybe something bigger and more transformational?

If I have to simplify Honeywell and make it more focused, doing more transformational dealers not a smart idea. Every segment we operate have large opportunities by default. We have opportunities in Aerospace. We have opportunity in energy transitions. We have opportunity in automation. And therefore, bolt-on gives us an opportunity to drive the better execution and low risk. And fundamentally, I have a rule of 5 when we do an execution, I look at 5 things. It has to be bolt on to a business. So some business leader has to raise their hand to say, I really believe in it. And it's going to -- we are going to do x, and my business is going to do even better. So it has to be bolt-on. It has to line with 3 mega trends. Also, I look at very carefully, is it pivoted to end market, which are higher growth in the next 10 years. And if you observe the investment we have made, they are more on defense. They are more on LNG, all those things are projected more higher growth compared to the base segment. So is it growing? That's rule #3. Rule #4 is sales synergies Honeywell will get cost synergies, make no mistake. I mean, that's -- we are a machine and we'll get the run rate cost synergy. But if we do not get sales synergies, we are not adding any value as -- so that's rule 4. And rule 5, of course, is a financial metric. We have to be disciplined. There are no trophy projects. We did while you are aware of winning 4, we did lose 1 deal during the course of the year, which we wanted to win. But the returns were not coming into our ZIP code, so we are not going to do that. We do want earnings accretion in year 1 after year 1 is over, and we want a 10% return in year 4 or 5. That's our metric. So when I look at all this, this discipline actually given us a strong momentum. It's rare in a large company when the rules are so clear. You can say this sounds very logical. But it's not very common in large company, the rules are super clear like this. So inbounds have increased a lot from my own team. And interestingly, in bond have increased a lot from bankers and some of the colleagues, CEOs call me to let interest on because there's a high level of clarity where we are operating, And this playbook will continue. As I said, I do expect Honeywell to be an active portfolio manager, both on addition and substraction, and I feel we are on the right trajectory there.

Yes. So maybe following up on that and flipping to the other side of active management. You mentioned earlier that I think you'd be disappointed if there's not material divestitures in '24. I know you can't tell us what you guys are thinking, but you also mentioned that you want businesses where you can monetize an installed base, and I see that. So is it fair when we look at the portfolio and we think, hey, what doesn't fit here? Is that the main criteria?

That's right. I think the answer should be known, and I won't answer the question. I have to learn something from the debate. There are some questions you don't answer and -- but I think on a serious note, the -- it should be obvious because if I have to be true to our statements, so near-term work is going to be all about fit into mega trends. I guess we have opportunity on that. But I also want to make sure that the portfolio management is not once and done. It should be an active process. So as we look ahead, just because you are a, say, an automation business, I have to think every automation business may not be good in Honeywell, right? You maybe at the tail end of it, you're a low growth, you're low margin. So that to me, I call it Phase 2. Phase 1 is more oriented towards fit into the portfolio just by mega trend. And we have not done that work. I don't want to preamble here, let's think about more. I just want to make sure that -- and also, let's not forget the exit process takes a lot of internal time, 5x, maybe 7x because we have to carve it out, so somebody can run it. I have to spend a lot of my time to make sure that it's carvable legal entities exist, factories are separated. From an outside, it may appear we are tightly integrated company as Honeywell. So while that's a benefit for most part and when any separation has to happen, it does put some additional work for us, and we have to do that. But expect progress, as I said, we're working hard towards it. We can't make any commitment, but the efforts are in advanced stage in a few areas.

I appreciate that. And maybe before I ask about the market and some of the segments, is anyone in the audience have any questions? All right. Hopping back into it. You mentioned earlier that the business is set up for good growth in 2025. Aero should decelerates mega, maybe decelerates a little bit as the comps are large numbers. I guess what businesses do you have the most confidence that are going to be better in '25 maybe than they are in '24.

I would say, I mean, across from we can spend in a minute on each segment. Our Aero growth will continue. Our past due is still a few billion dollars. But I can't promise another double-digit growth here, but high single is highly probable. I guess, that's where we're going to likely land. This is all organic. I'm not counting on inorganic revenue because '25 was also a year in which we have $2 billion of acquisition onboarded. So I'm just keeping it out because reported numbers are going to be higher. On the Building Automation side, I do believe that we're going to have our desired profile in that business is mid to high. And I think we have a -- if economy behaves, the way it's behaving today, we have high probability to hit that ZIP code. The reason is our solution business backlog is historic high. That's about 30% of the business. So 30% of the business, if it grows 10%, 3% is in the bag. Then there's the product side, there's a pricing. So if products don't grow and we just get price, I think that you can do the math there. There's a high probability. It sticks on that if products grow depending on the end markets, there is a further strength there. So I think buildings year-on-year will do better. That segment disappointed our shareholders for the last, say, 3 or 4 quarters, I'd remind everybody, we grew 14% in 2022. That should have been an alarm bell to me also that wide grows so much in a single year. So compounded growth does remain at a high level, 14% mid-single and it will grow probably low single this year. It's going to revert back to distributor stocking. That business also went into a unique shift of moving away from commercial real estate. Let's not forget, people like us are heavily exposed to it. Just because I want to go away, so I'm going to go away just because I want it. It's going to take a while for me to shift from a [ REIT ]. So all those things have occurred. Industrial Automation, again, I would expect our shrinkage is going to stop in Q4, and we expect to print a positive result. So a relatively basis, we go from negative territory '20 -- this year probably be 0 to maybe slightly negative, we'll be in a positive territory there. And energy business will be year-on-year on a similar profile, low to mid-single. So you can see directionally, we do expect a normal year in which few segments are in high single, few are in the middle and a few are in the low single. And overall, we should stay at 4% to 7%. I will see where the numbers land. I would say December will be a good time to consume everything because of a lot of dynamics happening in the markets in the economy. And I think right now, which I'm trying to project, it will be going a little bit ahead of time.

Yes. You talked earlier about the margin headwinds really just being a function of long cycle doing better than short cycle. Q2, we started to see some signs of short cycle getting better. When you look at the short-cycle businesses, do you see end market demand improving? Or is it okay, we're just done lapping the destock, comps are getting easier and...

It's a mixed story. I mean we saw the first business recovery in Honeywell portfolio was Chemicals business in Q1, which got reflected in our energy and sustainability numbers. Then we saw a recovery of our scanning and mobility business since late Q1, and that has a nice trend for rest of the year. Building automation, we saw. Now we are seeing recovery. It's bottomed out. It's in the recovery portion. But few businesses in Industrial Automation are still at the bottom. How much of that is channel stocking and how much is market? I've been asking that question to myself very honestly. And I would admit that we did not had a system of record where we could observe the distributor inventory at Honeywell scale. Now we have it. Last year, our $39 billion of Honeywell, $38 billion, $39 billion of Honeywell. Our business through channel is $11 billion. Just rough numbers. And about half of that is through distribution channels. So we should know 100 of these folks, and you're supposed to stock 60 days and you're sitting at 70 and we had the data [ Spock ]. And therefore, a judgment was made on recovery without the input data. Now we have fixed it. Now we have a system of record at Honeywell where all distributors are onboarded, and we have record of sales and sales out correlated and therefore, planning will be far more sophisticated. It's a lessons learned of this whole destocking. We need a system to -- when you have hundreds of distributors spread over so many countries, the rules of PMI is going to be up and those are directionally correct, but they are not equate enough. And that's a subtle difference on where we felt the year will go versus what actually happened. And we're going to be far more accurate in our projection in 2025.

I appreciate that. Maybe some questions on the segments individually. Aero Tech, biggest segment, best growth, obviously. How do you see the Aero supply chain today? And when you look -- I mean I know aftermarket is a lot bigger than you guys in OE. But is there any concern on the OE side that there's a lot of work in process inventory and ultimately, it could be the only end market that hasn't destocked yet? And could that be coming?

Yes. I mean, I would say our past dues are still so high that they are delinked from the demand side. I mean, it continues to be a supply-constrained market. That fact hasn't changed. We had forecasted that will change by Q4 this year. That didn't occur. I think it slipped on to 2025 now. So I would say that the commercial aerospace, the demand of Airbus Boeing would not really determine our growth rate next year. It will be our ability to supply them. But also let's bear in mind that the defense has become the highest growth vector in Aerospace, and that's about 35% of Honeywell business give and take. This is without the acquisition of case. So probably it's going to inch in a slightly higher number. That's going to grow at a higher rate next year. So when you do the sum total of past due recovery, defense growth, I do believe we are on the right trajectory. And not only for '25. One of the learning for the last 12 to 18 months is Aero is highly cyclical. That won't be true until 2030. We have done our modeling. Now I wish I won't be wrong having stated that, but our modeling suggests that how this market is shaping up between the demand in business jets, commercial aerospace, defense, this is going to be a long-term growth market. And those projections are without any revenue for urban air mobility, which we have not modeled. We have more than $10 billion of wins in our backlog. And I personally believe that's going to happen. Someday, if large cities have to resolve their issues of traffic, this is the most elegant solution, but it's hard to do because the new regulations are required. So we're working very hard to create that. So therefore, when you add it all together, defense being a new growth vector, urban air mobility, the continued growth in commercial and business jet, it's a long-term growth trend for a while.

I appreciate that. Maybe going over to Industrial Automation and Process Solutions specifically, you guys are calling for a growth pickup here into the back half of the year. How are customer conversations going in the process market and around projects over the next 12 months?

Look, the core business is more around the growth is more around aftermarket services. That's where we have very well-established franchise. That's a larger portion of our Process Solutions business, our software. And so it's probably one of our showcase of our business model software and services are way greater than projects. So when projects come down, our growth goes down, but not the income. Projects we don't make much money. And that, to me, is more of our showcase to say, yes, the good looks like this. Your question, the growth in Process Solution is going to come by pivoting to new verticals. How much would move towards hydrogen and SAF and ammonia. We are focused very heavily on energy storage. We believe that the planet needs battery energy storage at scale and battery energy storage is a complex control problem because you can't just keep a battery, you have to manage it. You have to connect it to the grid. So we have established a base position in that. So shifting our pivot to some of these new verticals, but continue to monetize our installed base at a high single, that's going to be the model in Process Solutions.

Appreciate that. Maybe going over to Advanced Materials. I think at the conference, we're going to hear a lot this week about the refrigerant changeover that's coming on the HVAC side. What does that mean for Advanced Materials and I guess, Solstice specifically?

It's a mix change within the product line. I mean our Fluorines business is now in excess of $1 billion. So I see that as multiple SKUs. So for us, 410 shift to 454, so 410 was higher margin, 454 is slightly lower margins. But then at the same time, the new SKUs are coming like for heat pumps, which are higher margins. So overall, it's a wash for us. I mean there's no one category which swings the profit profile. We have a business which is high income business, and we expect the margins to stay at the business level flat within the product line level, yes, there could be some movements up and down. But for Honey, you will hear that from our HVAC peers, and no Carrier and train both will be -- they are our huge customers. So their commentary may not match with our commentary because we have fixed long-term price contracts with them. So what we observe they may not observe the same because we have very different dynamics between us.

Appreciate that. Only a minute left here, maybe going -- staying in ESS and going to UOP. Can you maybe talk about the strategic nature of UOP, how it gets you close to the customer? And ultimately, what drives growth in that business above just refining flows?

I would say the best way to think about UOP is McKinsey of Energy, or BCG of Energy. We don't like McKinsey. This is a company which invents technology by which the new process operations gets created. Done it for 100 years. We talk about energy transition. UOP says, this is number 8x energy is getting transitioned since the last 100 years. So this is not new. Will it create new molecules. The business model is simple. You sell technology to build a plant, charge a license fee. Historically, it was refining. Now it's increasingly going to be petrochemicals and new energy molecules like SAF and hydrogen and then make money through selling catalyst, which is evergreen because nobody shuts down their plant and our catalyst sale, we exceeds our process technology sale by a wide margin. And that's a cycle on that number. I mean, if one business I want to personally bullish on in Honeywell, it's UOP. This business will grow at the same rate like Aerospace for the next many years because energy transition is a slow journey. This is -- there's no fast train and slower it take happens, better it is for UOP. Faster it happens, the projects will grow faster and catalysts will lap up. So I think there are scenarios here. but we remain extremely bullish. I think it's important also to say that, that business gives us our exposure to customers. Customers, I practically know CEO of all large energy companies because of UOP. They need to know what UOP is doing or will do and therefore, it's impacted our strategic plan because any plan there is a few billion dollars and our views matter a lot in that. So it's a great part of our portfolio, gives us a lot of tailwinds in Process Solutions because every time you sell UOP, Process Solution gets the benefit of catching on with the Elder Brothers. So we definitely get benefit on that.

Yes. No, definitely feels and I appreciate, but we're up on the half hour. Thank you so much, Vimal. Very much enjoyed our conversation.

Thank you. I Appreciate it. Thank you.