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

All right. Good morning, everybody, and welcome to day 2 of the Industrials and Materials Conference. My name is Joe Ritchie. I co-run our U.S. Industrial and Materials business unit. Really excited to kick off day 2 with Vimal Kapur, the Chair and CEO at Honeywell. And Vimal, I know you wanted to open it up with an introductory -- some introductory comments, and then we'll kick into the Q&A.

Sure, Joe. First of all, thanks for having me here. And Joe, we were just recalling this is my second time. My first time came in 6 years back. So it's always good to be back here. I would say I've been in my role as a CEO for 17 months and Chair and CEO for 5 months and executing on my strategy to transform Honeywell into a growth-oriented company, and there are 3 pillars of that. We started with simplification as a foundation. And last year, October, we announced that we're going to run Honeywell into 3 megatrends: aviation, automation and an early transition. And that caught a very positive reception from customers, employees and shareholders because we started on the journey of something which we can explain and what we want to execute on. And then the 3 pillars of the strategy are the portfolio transformation in which we made meaningful progress, 4 acquisitions, nearly $10 billion of investment, 1 spin, 1 divestiture. And I believe when they get completed, the compounding effect of that will help us to shape the organic growth. The second priority has been driving organic growth across portfolio. And we're making meaningful progress to understand our new product spend, our capability on offering management. And one can argue the results are not yet to be seen because of the cycle to drive improvement, but I do believe we are making rightful progress there. And finally, we are pivoting our operating system to drive only operational excellence, which have been our historic strength, while we keep that strength, but also pivoting to drive organic growth. So how do we have an operating system, which also pivot towards growth apart from driving the operational excellence? So combination of the three, making the right progress, and I do feel confident we are headed in the right direction.

That's great to hear, Vimal. And then so why don't we kick it off and just address the elephant in the room. So Elliott took its largest ever stake in Honeywell, calling for the company to break up. I just -- why don't we start off with what your thoughts are on the letter they sent to you? And how much have you engaged with them at this point?

So I would say, first and foremost, the shareholder value creation is my job. That's why I exist. And we constantly look at -- I constantly look at actively different ways how we're going to drive that. So the actions, which I talked about, we have been working on portfolio transformation, organic growth acceleration is with the effort to drive that outcome. We actively discuss that with the Board all the time, different ways and means to do it. Now to Elliott's letter, we are engaged with them. We actively engage with our shareholders, as I will do it today. And given our goals are aligned, we both want the same outcome, shareholder value creation. So we'll constructively work with them and find the right outcome, which is good for our shareholders and good for our company.

And I'm just curious, clearly, you've had conversations with the Board about this as well. How has their reception been?

We are -- I have, since in my role as CEO, actively discussed with the Board different options to create shareholder value. So just for the benefit of doubt here, the subject that split could be one way to create shareholder value has absolutely have been debated. And there are different pathways always to create value. We are on a certain pathway today. It doesn't mean other pathways are less feasible or more feasible, and that's my job, to find the most valuable way to drive the shareholder value.

And I know -- look, I know it's still really early on. The last time there was a public activist interest in Honeywell was a few years ago, 7 years ago, and Third Point took their interest. At the time, clearly, different CEO. But at the time, Honeywell responded publicly fairly quickly to the letter. Any thoughts around any type of public response at this point?

Look, it's early days right now. So I think we'll take the right steps. It's few days actually since this event occurred, and we'll do what will the right steps in this journey. So I would just say stay tuned.

Okay. Yes. Makes sense, yes. Shifting to the news from this week on the Bombardier partnership. Just maybe talk about the agreement, to some degree, the launch contribution. I think the accounting for those contributions, I think, was -- a lot of people didn't fully understand it, but also in the context of the resolution of the litigation that was pending between the 2 companies .

Yes. So I think the headline there is our agreement with Bombardier for large programs for which we are going to have our engines and our avionics and our sat communication part of those programs. The estimated value of those programs is $17 billion in the life cycle. A typical life cycle in aerospace is somewhere 25 to 30 years, just a rough order of magnitude. This is probably, I would say, one of the largest seed in our Aerospace business history, just to put everybody context. So it's a great news for our shareholders because these things, as an example, some of our largest revenue stream in 2024 and 2025 is from the similar agreement we had in 2007. So these things really compound over a period of time. And we believe this is a -- not only believe, it's a fact that it's an outstanding outcome for Honeywell and also Bombardier to have this agreement. Now the launch contribution is a normal way in this industry. This is not the -- a Honeywell specialty that we have offered something unique here. If you see our peers, they historically have done similar moves. The how this is done as a matter of commercial agreement. And we have taken approach of the early payout of the launch contribution. So our Q4 guidance haven't changed. We are on a glide path to deliver what we stated. This is an accounting treatment of contract revenue, which is required to fulfill the obligations we have towards this. This will also have, as we have stated before, no impact on 2025 in any which manner. It's a very positive news. The fact is that it has to be treated this way is a reality we have to treat it and get on with our execution there.

And the roughly $400 million number is -- seems higher than some of the launch contributions historically. Maybe just discuss -- I know, at a high level, you can't fully get into the details why the number is higher than typical contribution.

Just -- I think the launch contribution depends upon the size of the deal and the tenure of the deal. I think, as I said before, it's purely a matter of negotiation between the 2 parties. I won't be able to establish that there is a similar reference here. It's x percent of the deal. There is no such -- it depends on the program and what both parties agree. And the construct of these programs tends to be confidential. So we enter a confidentiality with Bombardier not to reveal more than what we have said that in our press release.

Okay. Fair enough. Let's shift gears. So you talked about active portfolio management. You've got -- I've got to give you a lot of credit. There has been a bunch of deals that you've executed in your time as CEO. Talk about maybe some of those acquisitions, how the integration is going, what you've learned so far about the businesses that you've acquired.

So all the acquisitions we have made, they are, first of all, aligned with our mega trends, so that we stay consistent with what we said, 2 in future of aviation, 1 in automation and 1 in energy transition. And the first comment I want to make is that we will stay consistent with that playbook. We're not going to wander around and find something in a different manner. Also all the acquisitions follow the Honeywell business model, which is create installed base, monetize installed base. And we want to build Honeywell, I want to build Honeywell around that business model. The spins we did of Chemicals business and divestiture we did, our Personal Protective Equipment business, because they don't naturally follow this business model of create installed base and monetize installed base, they are good businesses, but like anything else, we are not the rightful holder of that, and we should let the other -- in case of Chemicals business, the spin handle it. And in the case of divesture, the new owner handle it. To your point, each one of them are under integration process varying degree. Access Solution is probably 6 months into it. A few are like just a couple of months into it. But my initial read is that each acquisition happened spot on to our strategy. We have a strong conviction on meeting our TBA. Of course, our internal goal is going to be beat the TBA and bring some upside for our shareholder. But the defense megatrend, in case of Aerospace, I don't have to debate that. So case acquisition rights plays in the heart of it. LNG, we have a strong conviction. It's a transition fuel. There is an investment cycle of that for the next several years. So it's going to do well. That's our assessment. And Access Solutions business is really built upon the thesis combination of near-shoring. We all talk about near-shoring, and a lot of companies are going to benefit. All near shoring is an asset. There is a building. You first need to make something on which you make manufacturing. You by default require access control. If you have a sophisticated manufacturing of semiconductor, EV cars, data centers, that's where Access Solution is required. And the business is very U.S.-centric as we acquired it. So we do believe that 80% of the revenue today is U.S. Honeywell Building Automation business is 40% U.S. So we can scale it globally because this demand is across the world. So all the acquisition, I do believe, are going to help us to drive -- proper our organic growth, that's a comment I made earlier. We are doing it thoughtfully, so that we indeed make this as a pathway to drive our organic growth. The $2 billion can argue is not big enough. But then compounding effect comes. I'm going to continue to do similar momentum in '25 and '26 and the years to come and make portfolio management as an active part of Honeywell execution.

Great. That's good to hear, Vimal. I guess, on the flip side of things, you also have announced some divestitures, CP&E and the Advanced Materials business. If I take a step back, your predecessor did a lot to connect the enterprise, right? And we already had the discussion around Elliott calling for a split. As you think about the portfolio today, what can you do easily on the margin versus maybe like -- might be a little bit more difficult because of what's really happened over the last 7 years in connecting the enterprise?

Look, the margin expansion is definitely a strength of Honeywell. And I would say that given that we have delivered elevated margins over many years, some years, we have delivered margin expansion of 90, 100 basis points, our commitment is 40% to 60%. So if you take a CAGR of that, we are on a glide path of that. I don't expect that to change. The reason is that the levers by which you can drive margin expansion can change, but not the fundamentals. So the levers I see look ahead, for example, is definitely direct material savings, which was not a lever for the last 2 years, but clearly has played out in 2024. And what has changed there is it's not the normal way negotiation and you can buy more things from more attractive cost locations, but also how we are doing value engineering work. That's become our strength. That's a big portion of our direct material savings. We continue to get better with pricing. I think one thing we learned from pricing during COVID is much deeper understanding of pricing execution at the product line level, at a country level. So that agility is giving us more ability to help us expand our margins. So it's a different thing. And of late use of AI, I would say, in our operations, we have been -- given all the work Darius did, Honeywell is heavily digitized. And in the use of AI, use data first, and you need to be fundamentally digitize as a company. So we took advantage of our capability, and we applied AI in software development, software testing, customer experience, sales function quite extensively. So there's certainly a productivity benefit of that. So when you start adding it all up, it's a meaningful number. And I don't see any -- I don't have any concern at all, our ability to expand margins. One last data point I'd share with you is this year, our revenue will grow, give and take, somewhere around, say, close to 4% based on our guide. Our head count is flat year-on-year for the same revenue number. I don't have to give any more evidence. So we generated this much more revenue without adding any people. Of course, people move within the businesses. That's an evidence of our constant productivity journey as a company, and we expect that trend to continue. This is not going to stop.

That's great to hear all the details on margins. Just maybe going back to the divestitures and how you're thinking about trimming the portfolio from here. I know you've talked about a 10% plus target. So maybe just, are there things that you can continue to do without disrupting the company?

Look, yes, there's a lot on the plate right now in terms of making 4 integrations work. It's never easy because we also do deep work on IT integration in year 1 as a company policy. We learned Honeywell has been not newbie to acquisitions. So we learned hard way that earlier you do this work, better off you are. So we -- so to your point, from a capacity perspective, yes, we are at the peak. But then some of these are going to wind down and will create new capacity. And I expect normal year, 2 to 3 inbound. And anything which doesn't fit into a portfolio moving forward will be more driven by my business model question. If the business constantly don't deliver aftermarket either through services or software, it may be an Automation business, it may be Aerospace business, it may be Energy Transition business, is it a fit in Honeywell, because that's what is Honeywell. We need to live it to our principle. So I think that will be the, I would say, next round of constantly looking at optionality. And based upon opportunities, we'll take some more actions.

And then just to be clear, the 2 to 3 inbound is typically folks interested in parts of your portfolio.

No. I would say 2 to 3 inbounds for us to make acquisitions into Honeywell. Yes, there will be -- we make inbound to others, others make to us, that's normal way. I would say there's nothing extraordinary about it. But I was more mentioning that do expect 2 to 3 M&A acquisition inbound into Honeywell in a normal year. That's how we want to transform our portfolio. That's why I mentioned earlier, $2 billion in 2024 is a good start. But if we keep this momentum, not that I can do $2 billion every year, but even if we did $1 billion for a point of discussion, then it starts compounding. And that's my commitment that active portfolio management will be part of my act as a Honeywell leader.

Okay. Let's shift the gears to organic growth. Clearly, on the eve of 2025, this year, you're going to post about 3% to 4% organic across the portfolio. At the same time, you've had very significant headwinds in the Industrial Automation business this year. So maybe just as you think about next year, is the long-term target of 4% to 7% achievable? And is there -- as you see things today, is there an opportunity or a good chance that you can do the high end of the range?

I would say we'll provide the guidance normal way late January, early February. With the one thing which I've learned being CEO is that for businesses which have -- we have exposure to 3 broad end markets and multiple countries. The things are so dynamic. Just as an example. Stuff happens in Korea, stuff happens in France. This 5% of the annual revenue happened in the last 2 days. So better to do it later than earlier because you jump the gun and then say, "Never mind." But to your point, if I look ahead next year -- and so we'll provide the guide normal way in our Q1 earnings call. I do expect at a high level, Aerospace is going to come to more at a normalized level of growth. So think about mid- to high single digits. Likely, we'd like to maintain high single digit there. So it's -- it cannot -- it will not sustain its double-digit growth, which we have delivered for 8 quarters in a row. But at the same time, it's not going to shift to low single-digit either. We do expect -- the Building Automation business is slowly cycling up. We started the business with a negative growth and to neutral to some growth, and we are trending in the right direction in Q4. And I think exit rates are good for us to have, I would say, use over normal year in Building Automation. The Solution business, in particular, is doing well. We are finally getting share in data centers. That is not our strength, but we are slowly paving our way through that. So that's helping the products in Building Automation are trending up. But more work is required there. We're expecting that trend not to ramp up a lot in 2025 based upon the facts what we know today. In the ESS business, if I for a minute not talk about Chemicals business given we are on a path of spin and we'll complete the spin during course of '25, the UOP business has a strong booking. So we reported Q3, UOP had historically high bookings ever in its history. So we're going to carry a good backlog. And the catalyst demand on aftermarket remains stable. So net-net, that business should perform in a -- it should have a good year next year in 2025. And Industrial Automation is our challenge. We had a tough start of the year, high -- negative growth for 3 quarters in a row. We do expect things to be more settled by Q4. But I'm not expecting that a business which was high single-digit contraction in 2024, it's going to magically start growing in 2025. So we have to do more work there. Short cycle recovery is required. The core HPS business will follow the trend of the market. So you can think about what our peers are saying, will perform in the similar way. It shouldn't be much different. But rest of the business, Industry Automation, short cycle. More recovery is required. More work is required by us on organic growth and also more work is required by us on portfolio on that. So that certainly is going to be the part which we require more work.

Super helpful. I'll open up to the audience in a couple of minutes. I just wanted to follow up on a couple of the comments you just made. So on the Aero side, the mid-single digit to high single digit, how much of that is a function of the Defense supply chain normalizing this year? And you're seeing very healthy good growth rates in that business. And then also, any comments you want to make on the OE and aftermarket side of the business?

So I would say that the Aerospace next year, we expect the aftermarket to more normalize versus elevated rate it had seen over the last few years. The OE rates will remain high. It's both good news, bad news. Good news because we continue to accelerate creation of installed base. Bad news because then it puts margin pressure, because OE is lower margins compared to after market. And the Defense and Space will be performing at a better rate than historical rate. The bookings are strong. The trends are strong globally. Our business is rapidly expanding. And then case acquisition is going to be part of that because it brings more Defense portfolio. So overall, I think it's going to be -- Aero should have a good year in 2025, even the years ahead. The things we are doing like Bombardier deal, you're talking about Aero, it's important for me to mention that urban air mobility, something I'm very passionate about, is becoming a reality. Something everybody should take notice on that FAA has passed their certification process. So this is what was the unlock, not that now the planes can fly. We have to certify it, but that was the missing element. Now the cycle of certification will start, and UAM can become revenue stream for our OEM customers, '27, '28. This is now imminently happening. So that will become a revenue stream. We have $10 billion of wins in our backlog, not purchase orders. And that's not in any -- that's not in our model. That's not in our forecast because it was more of an ambiguity there. So when I pull this all together, I have a strong conviction on Aero continues to be on the right glide path for a growth for many years ahead.

Helpful. And then in the context of the growth rates that you just mentioned, the margin entitlement might be a little bit different next year. I know the expectation longer term is segment margins above 25%. But as you think about each of those different business segments and where you'd expect margins to grow the fastest maybe the slowest, any comments around that would be helpful.

I would say we will expect at each business level -- I think I'll divide that question into 2 parts, the segment level margin expansion and the business level margin expansion. Fundamentally, as I mentioned before, we are seeing margin expansion across our businesses. The primary reason, if it is not showing up in the reported number, is the mix dynamics across the board in multiple segments. Aero, OE versus aftermarket in case of buildings, projects versus products. So there's a different mix happening compared to our historic levels. To your specific question, I don't have those numbers top of my head to say how much each business will do it. What I can tell you is that Aerospace probably is going to see a similar trend as we have observed, continue to grow margin expansion, bouncing around the same number given the OE mix. Other businesses, our goal is always to strive to drive margin growth. So we'll come back in Q1 earnings and give you more perspective for 2025.

I'll come back to that in a second. Any questions from the audience? All right. Let's keep going. So in terms of the restructuring and repositioning that you've done across the portfolio, where are you taking out the most cost? Where do you see near- to medium-term benefits across the portfolio?

Cost, you asking, Joe, in terms of the fixed cost or...

Yes, I'm talking about structural costs that you're taking out of the portfolio.

Structural cost, the good news is we constantly look at our fixed cost as a percentage of the revenue as a standard work every year, every quarter. And so we never do any big banks in that sense because it's a discipline to say what's my entitlement of fixed cost relative to revenue and what's the pathway to do it. So if you typically see in every quarter, we'll announce restructuring. In a typical year, this year, we've guided somewhere been $150 million, $200 million restructuring cost, and that is our strength. We continue doing it every quarter to create the pipeline of productivity for future years. And I don't expect that trend to change materially moving forward. It's multiple smaller things you do, which could be footprint rationalization of the factories, for example. We're down to 150 factories now. At one point, it was 300 plus. To work on that nature, there are other benefits, which will get on productivity using different software tools like AI, in particular. Yes, so I feel confident -- what I feel confident is we would not miss our goals of fixed cost as a percentage of revenue. And as we continue to grow, we only should get leverage at a point of the specifically a short-cycle businesses get high leverage as the volume grows because we are not going to add more factories just because we got 5% more volume.

Fair enough. We were lucky enough to spend some time with your DC team at the end of September. I'd be remiss not to ask the election implication question given that we're only about a month removed. So just any thoughts on the next 4 years?

Look, I think this is a process, which companies like us do every 4 years. So I think every 4 years, this question come in front of us, and we were prepared for either scenario. . I would say there are both defensive and offensive opportunities for Honeywell with the new administration. The defensive are common ways, the outcome of tariffs, what will happen and then Texan jobs act and how the corporate tax will play out. Nothing specific to Honeywell. I would say, tariffs in particular, we built a playbook last time when the tariff happens. So we have to repeat the playbook should it occur. At the same time, Honeywell has local for local strategy. So we probably are going to be differentiated compared to other should tariffs occur because we do have less things coming in because of the large amount of localization. But still, there are things which we'll have to really worry about. On the opportunity side, I would say, I certainly see opportunity in LNG. I certainly see opportunity in acceleration of defense and urban air mobility working with the administration. Yes, so there are pockets of opportunities and there are pockets of defensive moves, which we'll have to really work on as the new administration comes on board.

Helpful. I want to go back to the conversation we had earlier around some of the acquisitions and particularly the Access Solutions deal since it was the largest one announced to date. There's some concern heading into 2025 on not Access Solutions specifically, but the commercial end markets in the U.S. At the same time, to the point you made earlier, there is a significant amount of investment that's occurring from a mega project perspective here in the U.S. and the companies that are selling into these facilities are likely to start benefiting in '25. So in that context, how do you think about what trends are you seeing in the business today? And then how do you think about the accretion that you could potentially see from the business and in the next 1 to 2 years?

If you see the Access Solutions business, the last 10 years of revenue before Honeywell acquired it was more of a mid-single digit. That's a fact which is generally not known because this business was reported by Carrier as an aggregated segment. So the aggregated segment shows a lower number, but this business was always mid-single-digit on a 10-year history, including COVID year. So we have a good base. The 2 factors of the growth we see in the business natural way is, first, is continued more investment in high-value assets. As high-value assets are invested, data centers, pharmaceutical manufacturing, semiconductor manufacturing, the Access Solution is a big part of that because these are high-value assets. So you need to have a sophisticated security system. The second factor we see, which is going to enable growth for us is that if all the Honeywell portfolio of automation between industrial and building automation, the offering or product line, which will move to cloud will be security. because security is not -- is being -- is moved to IT for last. Since COVID, security is not bought by -- there's no security buyer. IT has become security because it's become more sophisticated integration of software, move to cloud. So why it matters? The reason it matters is that the installed base which exists on on-prem security system, that will eventually also get migrated. So that certainly plays out to the growth algorithm for this business. And last, not the least, which I mentioned earlier, the Access Solutions business, as we acquired is heavily concentrated to U.S., and we are very global. So we do expect -- and we're already seeing robust proof points that we are able to take this business globally because the value proposition is very, very strong. So it's going to be, I would say, accretive to building automation growth. I would be surprised if this is not true. But the early data I have seen, it should certainly help us to continue to drive growth in Building Automation.

And you mentioned earlier that paraphrasing that you've historically been under indexed in data centers that you're starting to see momentum. Just provide some color around what's happening there.

So when I -- we were late entry into the party. And we set up our organization in early 2022 to address data center customers. Obviously, took a while because why they should switch to us if they already have automation system provider versus a compelling reason. But now 3 years into the journey, I would say, for all the hyperscalers, we have presence across the board. And we are getting a meaningful share. And our bookings in 2024 are in hundreds of millions of dollars now. It's a good place to be starting from 0. And we expect that number to grow at a very high rate in the next few years because our strength is, which I never doubted it, the good thing about the data center business is you can count the customers on 2 hands, the hyperscalers and the big data center builder. They do this at a global scale. They build data centers in U.S., in Europe, in Asia. That's what Honeywell. And Honeywell is good in global scale. Honeywell is good in program management. So it's not about the product alone. It's the whole value proposition package. And I think once that story got across, we are getting more traction that it's not about product, it's about the life cycle value creation we provide. And that's giving us momentum in this space. I always worry when we have high market share in some segments because somebody will take it. I always get excited when we have no share because we have nothing to lose. We can only move up in one direction, and that's the direction we are headed towards.

That's -- Yes, that is a good problem to have -- did you have to reorganize your -- either your field organization or sales force? Or how did -- how do you attack that?

One change we have made in Building Automation is we are reorienting the business towards verticals. The 3 verticals of choice we have chosen is for high growth is data centers, hospital, health care, hospital, whatever word you want to use it and hospitality, hotels and entertainment center casinos. We believe these are all megatrends here to stay forever. And our sales force has been reorganized by verticals. So we have specific business development people who call on the customer to do business development work, specification work, whether we sell a solution or whether we sell a product. This change we made over the last -- this year. You can see -- we will expect to have a lot of Honeywell sellers in this kind of segment, and that's a shift we have made to get more demand onto our way.

One more question around the comments you made earlier regarding the Bombardier agreement not impacting 2025. And so as we think about -- we all have our estimates for 2025, but think about like the free cash flow implications, seems like there shouldn't be any implications from this recent agreement. But how should we think about free cash flow growth from here on out?

Look, my goal is 2025, we break our lack of momentum on free cash flow. My goal is that free cash flow grows greater than income growth. So this year, if you take our guide, there should be more than earnings growth, free cash flow growth in 2025. Why will that happen? Inventory unlock has to happen. Aerospace is a $1 billion plus inventory. So our goal is to now start dialing it down to a smaller degree, starting 2025, even a smaller number will help. So then all income flows into cash, plus some working capital reduction. And that's the goal we are working towards. And you'll hear more from us in Q1 earnings call.

Great. Vimal, I'll turn it to you in case you have any closing comments.

No, again, thanks for having us here. And I do feel excited on where Honeywell is headed. Sometimes, it can feel a bit of disappointment on lack of progress, specifically Industrial Automation. But my commitment to everyone is we are executing to what we said, and we are going to demonstrate progress in the time ahead. So thank you very much for having me here.

Thanks for coming. Great to see you again.

Thank you.

I appreciate it, I really appreciate it.