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

All right. Thank you, everybody. I'm Chris Snyder, U.S. multi-industry analyst here. No better way to kick off the conference than with Vimal Kapur, CEO and Chairman of Honeywell. Thank you for joining us.

Thanks for having me.

Just maybe starting off high level, can you update us on the separation journey? Has there been any surprises or unexpected challenges or anything that's just kind of maybe noteworthy that's come up in this process?

So first of all, thanks, Chris, for having me here, and welcome, everybody, and good morning. I would say the spin perspective, they're progressing on schedule. We'll have our Solstice business spun off in Q4 this year. The Investor Day is on October 8. So those interested definitely should attend. And then Aero spin will be second half of next year, about a year-ish time from today. So no major surprises there, I would say, from an execution standpoint. The AM spin gave us a little bit of a warm-up of doing a spin and Aero is complexity is high. But we have a separate project team, which executes that. So there's a lot of work, I would say. But what surprised me to your question is the opportunity set as I've been more and more focusing on my new role as the CEO of RemainCo Automation. The opportunity set in automation with the confluence of cloud, data and AI is way bigger than I had hypothesized when we made a decision to separate. It was known that something will happen. And fundamentally, cloud is providing us ability to connect, which means that our ability to service our customer and our served, evolving market is going because friction to connect is basically 0. So if I was having -- not able to serve a market, so that's kind of a basic table stakes. So there's a benefit of able to serve my customers better, hopefully pick up more gross margins because cost to serve reduces, but I'm also able to connect enterprise versus a couple of plants, warehouses or building. That's a new dimension. We were not able to do that 3 years back. If somebody says, give me visibility of 40 buildings, and we can just roll up our eyes because there was no technical solution to deliver. Now we can do that. But the big picture, which is emerging is not these 2, is really as we are connecting, Chris, we now have 20,000 customers connected. And the data which is coming and the data science behind it, which I'm also learning ontology, which cuts data across different sources and builds a new wide outcomes, it's a totally eye-opener. I was not a strong believer myself on the opportunities it will create. But what has happened over the last 6 months and the customer success we are getting has also made me an unconvert, which is making me exciting to your question, that's a fundamental shift on the confluence of cloud, data and AI, the opportunity it creates. It's going to transform automation industry in my view, and we'll see how we participate and take benefit of that.

And is that really the value that's created in the separation? You guys can now maybe better or more effectively identify opportunities, invest and capture that?

Absolutely. I mean the thesis is each company is on program for its own future. Its capital structuring is to enable it to execute its own strategy, whether it's Aerospace or Advanced Materials or Automation with its own management team, which is focused on that. So I think the thesis that separation brings more focus clearly is valid. I've been very conscious that we also maintain the scale while we are becoming thematic as an aerospace or automation in particular. We don't want to lose the scale and capability the scale brings. And I'm quite pleased on where we have accomplished that each entity, aerospace and automation will be about $20 billion revenue roughly, not precisely. And it positions us very well to go from that platform to create a higher scale and momentum.

Maybe last one on the separation. You guys have remained busy on the portfolio this year, both buying and selling. Is there anything big or material that we should be thinking about between now and the spin? And then with that, anything that you would talk about on Quantinuum?

Yes, sure. So I would say that one of the unique feature of Honeywell spin process is we are simultaneously also doing the portfolio work. which can sound a bit risky to say why we are onboarding more work while you already have this work. But my conviction is that we don't want to sit here a year from now and say, while we have done the spin, now we have to do portfolio work, right? So the portfolio we are building specifically for automation is built upon a promise that we are moving towards common outcomes. What we have observed is over the last few years, customers have moved around from hardware and products to common outcomes they want to drive energy efficiency, productivity, operational excellence, safety, cybersecurity and so on. So how do we have a portfolio which can drive common outcomes? We pick a few. We can't pick up like 25 outcomes. We prior to pick 5. And then there's a commonality that this outcome applies in these verticals. So we have a higher amount of replication and more so with the power of data, the impact of that is going to be higher. So a lot of our portfolio work is -- was focused on that. I think where we sit today, after we complete the exit of personal protective equipment business and announced a strategic review of our productivity solution and warehouse automation, I think we're largely done on our current portfolio from any exits which were acquired. And on an onboarding perspective, we have made 6 acquisitions, 4 of them are in automation, 2 are in aerospace. I mean I won't say on additions, we are done. Obviously, there'll be more opportunities which may come in, but we are not predicated on that. Our earnings growth is not counting on some big acquisitions we are going to make. So I would say you can feel that we're going to be more stable on the platform -- on the portfolio work. And our goal is and when the spin occurs, our portfolio works, this innings is also completed, and we are able to then focus more on driving execution. The last point you made on Quantum, I would say we did complete the Quantum fundraise. You should have seen the press release, $600 million, want to go up to $700 million or north of that. I think the good news is we are able to get many new investors. So that's what's unique about this round is money is fine. We, of course, need money to progress our cause. But a number of investors which have come in, that shows that interest in Quantum is going from modest to more people are wanting to participate in this. Now we really -- I really see the next step up for us is given that we got the funding we needed and we completed the Phase 1 of our journey on having a hardware platform, which we have prove on work. That's why people are putting money, is now onboard customers which can use Quantum to do applications, which classic compute can't do. This is that movement now. And the 3 verticals our Quantum team is focused on is research and life sciences, how to discover molecules faster, banks and governments for cybersecurity on encryption. So each of these 3 customers in that sense, probably next 12 to 18 months, work with them on our platform and get that proof point to say, traditional compute can't do this, Quantum can do that. And that will become then the point which we are all waiting for. Then that's the point to say the business is ready for a new future, whether it's IP or other form of capital raise. But we think in the next inning of this. And earlier, the better for us as a Honeywell, we have been very committed. That's what we want to do. But we obviously do not want to run ourselves and get returns for our shareholders. I feel very pleased that we got $10 billion valuation. So goal, obviously, is we sustain this or we get to a higher level.

I appreciate that. Maybe moving to the businesses. You mentioned that you would be running RemainCo, the automation business. A lot of questions and interest on the Aero side. Can you just maybe talk about the process in identifying the management team there and maybe when we could expect some updates?

Yes. So I think one of the big decisions for obviously, for me and Honeywell Board is to now decide the management team of Aerospace. And we're really looking at a combination of 3 roles to satisfy 3 stakeholders because any decision we made that impact 3 stakeholders, of course, our shareholders, they want to know who is going to be the management team. The customers because they deal with the same people because it's a very narrow set of customer set. There are 10 OEMs and a couple of defense primes, right? This is not a very large universe. And then employees, there are 30,000-plus people. They want to know who's going to run the company. So we have to satisfy these 3 stakeholders. So there are 3 positions. We're looking at it to feed the interest of 3 diverse stakeholders. Nonexecutive Chairman. We think that this company will benefit from having an experienced nonexecutive chair for a period of time, the CEO and CFO. And each of these roles, we are looking for options. All 3 internal, obviously, a bad idea, all 3 external, obviously a bad idea. So obviously, there will be a balance between the 2 approaches. And we do expect that we should be able to make announcement of this in the next 90 days. Which will be about a 9 months ahead of when we think spin will occur, give and take, right? You don't want to do it so early that it's irrelevant. You don't want to do it so late that people get -- don't feel comfortable not to know the management team. So we are in the process. That's what I can share. And when we are ready to announce all of these 3 roles or some of this, we'll communicate that.

I appreciate that. And maybe just kind of turning to the business itself, staying with Aero. Obviously, great growth the last 3 to 4 years. I guess how long do you think the industry can grow above trend or above normal? And how much visibility does Honeywell have into the Aero growth?

I mean this question, what you're asking, Chris, today, I asked that question to myself in late '23. And what we found at that time was the cycle is up for a long time and Aero business will become $30 billion in about less than 10 years, about 8, 9 year -- organically. I'm just not talking -- this is pure-play organic. So to answer your question, the growth is more longer term. And we believe that we do say mid-single -- mid- to high single. And the question raises when we are so convicted, why you put mid in front of it. I think that's really a question of supply chain constraints, which occasionally show up. It's nearly impossible in my view to show quarter after quarter double-digit growth perpetually. So there's going to be some quarter in which you may not be able to do that given the complexity of supply chain, specifically on the mechanical side. But fundamentally, our belief that this business will perform on long term is very strong. And all the vectors, whether it's the OE growth is playing well. Defense has certainly become a new dimension of growth. Advanced Air Mobility is taking shape. It's a big -- we have a big amount of wins in our backlog in that. So all factors are progressing in the right direction for that business.

I appreciate that. Then on the margin side, the margins there have stagnated over the last 3 to 4 years, obviously, mix, acquisitions, tariffs. But you guys do have a -- I think, a 29% segment target out there. Maybe that changes post spin. But just in general, on that margin expansion, I guess, how do you see that trajectory? Kind of how do you see the cadence of margin expansion there?

So the margins for the business have been bouncing around between 25%, 26% this year. I think for -- I would divide the margin drivers in 2 buckets, what's more transitionary more in the near term and what are long term? There are 2 different drivers. The transitionary drivers are -- first is very simple, which will be over next year. We acquired CAES, a defense business. It has about 100 basis points of contraction on margin because of onboarding costs and all that. We've telegraphed that right in the earnings call. There's nothing new there. That's a known factor, which will go away next year. So that's an easy one. The 2 additional ones, which are transitionary one is the OE mix continues to be unfavorable to the overall mix. And given the OE margins are lower than aftermarket, that obviously plays as a headwind. And then the last one, which was not there at the start of the year, which came in is tariffs. Now this business is able to pass along the pricing for aftermarket very effectively because either contracts are linked to some indices or if it's a spot price, you can obviously reprice it. But the OE contracts are long term. And the term of the contract will determine when will we get the price. It's an important point. We are going to get the price, but timing may get delayed because contractually, it's not due till and hypothetically, for example, February of '26. So what should have been come in Q2 or Q3, it's not going to appear in '26. It's this outs of synchronization. It's not that business is not going to get it. It's an industry structure. And I jokingly tell to my team that somebody else's margin is inflated artificially and ours deflated artificially. So those 3 transitionary factors are occurring, which made the margins more closer to which was 27% to toggle around between 25% and 26%. We think that's going to remain stable. But there are 2 incremental points in addition to 3 transitionary points, which kind of makes the case for our 29%. First is our R&D spend is up. Now let's say, why that's a long-term trend and why it matters. Our backlog is up to $70 billion. So if you have to deliver that backlog, I'll just take an example, the commitment we made to Bombardier last year of a $17 billion win. We have to do some engineering work. We don't have to invent any new product, but the engineering work has to be done to repurpose the product for that OE that requires money. That delivery or shipment may not happen until '28 or '29. But if I don't do the work today, that shipment wouldn't occur. So in a way, the R&D cost going up is a positive signal for a business which is long cycle because this is not pie in the sky projects. These are contractually bound deliveries for which we have to spend money now because cycle is 3 years and stuff like that. And then the final point, which is long term, is the investments made by us in supply chain. They were necessary. They are necessary in the state we are in. We are getting the results of volume growth consistently, 10% for 12 quarters, 13 quarters now. But we have spent extra money from our pocket to get that volume, even though we are not bound to spend that money. So at some point, the volume leverage of that will come in. So when you unpack it, it looks like all the things are coming together literally, and that does create some bit of anxiety is the margin story not there. But fundamentally, the foundation is very, very strong. It is just events coincidentally coming together, we just makes it -- margins look more static at this point. So near term, the earnings growth of Aero will be predicated by revenue -- top line growth. But longer term, it will become a combination of both top line and margin expansion.

Yes. So if I could maybe follow up on the tariff price cost. So it sounds like you guys are confident that you'll get the price. Obviously, the contract in nature means it comes through later. So maybe there'll remain some pressure there, but the rate of change is positive. You guys are kind of closing that gap.

Absolutely. I mean it's not a -- so if the gap keeps shrinking as you approach a particular milestone. So it's just a time lag issue. If the industry is structured that way, I wish we can change it. But I think every OE will go through the same -- every provider like us will basically will go through the same cycle.

Yes. And then just kind of staying with some of the more near-term Aero dynamics. The OEM destock caught the industry by surprise. A lot of companies were impacted by that. Production rates are going higher. So it doesn't feel like it will be long duration to that. But I guess how do you see that side of the business shaping up into the back half? And what kind of visibility do you guys have on that?

So I would say the -- what we mentioned during our earnings call, there was a synchronization between shipments we made to OEs, specifically in U.S. versus their shipments. So -- and it was specifically asked by these OEs not to stop our shipments even though when they were not shipping. So that created a synchronization. That's why the cycle looked a little out of sync. That's behind us after H1. So you would see the cycle converging in second half of the year. And now from this point onward, there'll be much more similarity on the OE growth rate. It won't be exactly the same. So if OE growth, the curve will be similar shape, but we can be below the curve, we can be above the curve depending upon how many shipsets they already have from us. If they have less, we will be above the curve because they need more from us and if they have more. But the shape of the trajectory will be if somebody is growing 14% trajectory, you will expect from us similar rate moving forward. So that's definitely behind us. We are observing that as the quarter 3 is progressing. And we'll see as the results come in for Q3, we'll share the additional details.

I appreciate that. Maybe moving over to the automation business, which you will run. You guys have announced some -- a couple of big divestitures, warehouse, the scanners business, you sold safety a couple of months back. I guess how do you feel about the scale of that business as it becomes a stand-alone entity? And are there any areas in the portfolio where you see opportunity to add?

I mean, I would say the scale portion, obviously, as I mentioned, how do we find balance between the scale and thematic. And when we were going through this process, I talked to many of my peers who have gone through a similar process because many industries have gone through this. And I think one advice I got was we should not come to a point of thematic that we become irrelevant. So what is the finer point? And that's a balance we have been trying to do that have scale and commonality. So I would say in the state, we will basically serve 3 broader end markets, industrial, process and buildings. But what binds all of us together is the outcomes in these 3 are highly common. All customers are looking for operational excellence, looking for safety, they are looking for productivity. And we are focusing on commonality of outcome, which binds us together through our offerings. And the things which did not fit well in those outcomes, we felt we are not the best owner, let somebody else own it. So our future portfolio will be actually driven by 2 drivers. One, can we strengthen an outcome? For example, we acquired Access Solutions. We were not strong in security outcome, which clearly feel more and more customers need that, so we should strengthen that, right? So it's more outcome-driven driver or a market participation, which is higher growth. And in these verticals, there are some higher growth end markets and some not so higher growth markets. So LNG acquisitions, both for -- from Air Products LNG liquefaction business, followed by Sundyne high-speed compressor and pumps are in our belief that gas is going to be a critical fuel of the future and LNG will be a big play. And therefore, those acquisitions add to our strength in those verticals while it sustain our business model. So I think fundamentally, that's essentially our mindset is towards that. Our principle remains bolt-on. We are not looking for any transformational deals. We have worked very hard to simplify Honeywell. Now from this point, we do not want to divert and go into some different direction. So bolt-on will remain our primary theme. Some tuck-ins, too. Tuck-ins in my mind is more around an asset buy in which we did a couple in cybersecurity, a couple in fire detection, but those are more to improve the organic growth of our core portfolio. So that will primarily remain our themes around it.

Maybe following up on the building side, really good turnaround there over the last few year. It seems pretty Honeywell specific. We're not -- we haven't seen other companies in the space inflect like that. So I guess what's driven that? Is the Access Solutions, is that providing revenue synergies and just improving the overall business? And then what have you learned in that turnaround process that you think could be applied to the industrial side?

I think the buildings is an interesting story because we started working on it since 2019. We spun off our residential business in Q4 of 2018, and our history is instructive. So it's about 7 years back. Since then, we have been looking to transform the business, which is fundamentally the strategy of new Honeywell. We really believe in growth in 3 ways, 1 of the 3 ways. Either you pivot your business more and more to high-growth verticals so that you have natural participation in more activity, CapEx or OpEx or whatever the case may be. So that's lever one. Lever 2 is how do we mine our installed base more and more through recurring services or software, more so software with the power of data and AI, which I talked before. And third, how we drive new products to participate in these verticals or participate in software, but also protect your core. Because if you can protect your core and take some share, you will grow even faster. So those are the 3 measurements we have, mix of high-growth verticals, mix of software and services and new products growth. Building automation is doing all of them well. And our participation in high-growth verticals there is definitely in data centers, which should not surprise anyone. We started late, but we have a good position in both safety and security in those -- in that business, but also participation in health care. The world is building a lot of hospitals. It's not a well-known, well-advertised fact, but a lot of hospitals under construction and entertainment, hotels, casinos, people want to travel more. So there's a lot of consumption, so they are growing more. So their activity or participation in those 3 have increased a lot. They are far ahead in our connected strategy. That's a business which is leading the charge in Honeywell and connecting the installed base. And monetizing the data for new application. I'll give an example. We have more than 10,000 of our customers in fire business connected. And our channel partners, in this case, can configure a fire system from their office. So why that does matter? I mean what's a big deal about it? Because they don't have to travel, they have extra hours to do more work. This is a small business with 20, 30 people for them, every hour is precious. And they really love this product. This capability we did not have 2 years back. So it not only gives us the recurring revenue to license that software, but it also buy more of my hardware. It's kind of a knock-on effect, right? So certainly, they are far ahead in that, just one example. There are many examples like that. And their new product performance is very impressive. So I think all that is coming together. To your second question, the Access Solutions business, our thesis of sales synergies is playing out extremely well. Our direct channel, which we consider because the buildings whole business model is through channel, we have our own in-house channel. They are pulling a lot of Access Solutions business in the customers, specifically in data centers. So that certainly is becoming a big advantage for us. So sales synergies playing there are quite strong. But overall, the business is performing above our financial commitment already in first year of completion, primarily driven by sales synergies. Cost synergies, large company will execute well. That's kind of a table stakes. But really ROI really returns come from that. But overall, I would say I just want to make a finer point on all the M&As we have done, the 6 acquisitions, the net multiples Honeywell have paid net of cost synergies is 12, without any sales synergies. And I have not approved any deal in which there is no sales synergy. We are not interested because you're not adding true value as a company. So net multiples will be obviously lower than that. So we are truly creating value for our shareholders in a very responsible manner versus running for an idea. So that's certainly quite playing well. And these acquisitions are accretive to our organic growth. Things like CAES acquisition we made in Aero growing high double digits, and it will stay there for a long time. Access Solutions, we talked about very strong growth in LNG business, Sundyne business. So they all are really helping to propel the Honeywell organic growth rate. And 4 out of 6 are accretive to margins already. So it's a great story. I think the capability we are building, and we believe that will help us to shape our portfolio moving forward. And what we have done in buildings is the same strategy we are doing in process industrial, focus on high-growth verticals, focus on aftermarket services, both through services and software and then new products. That's going to be a story of new Honeywell. We are ahead in a few verticals, kind of work in progress in a few others. And as we come into 2026, I'm pretty excited on how our fundamentals are shaping up, and we are getting ready for the next year.

Appreciate that. And the industrial business and the building automation business, they both showed better organic growth in the first half of the year. I think you guys were the only company I covered to guide some of those shorter-cycle businesses actually softer in the back half of the year. It sounded like a lot of -- maybe some conservatism with whether macro uncertainty, maybe uncertainty around what's in the channel. So can you just maybe talk about what you're seeing on those businesses into the back half of the year? Was there some conservatism there?

Yes. Look, the business is performing on expected lines as we signaled during the second quarter earnings call. So we feel very confident on the revised guide we gave of $10.45 to $10.65. I believe we are going to deliver that. So just to reaffirm that point. I mean the short-cycle businesses are trending in the same way. But where we were cautious was the secondary effect of the current economic environment. As the tariffs get applied to countries specifically which are export-oriented, what happens to their domestic economy? I'm not an economist to figure that out. But clearly, something is going to go wrong or something is going to be negative. Similarly, the oil price hanging into $60 has a consequence of the spend of the energy company on the capital cycle. So the secondary effect, I would say, were less clearer when we did the earnings call, and they were essentially saying, we don't know what we don't know. And therefore, we are kind of suggesting H1, H2 very similar but how things are progressing, and that's what factored in our guide. We are progressing well. And I think we'll learn more as the impacts of the tariffs really settle because they are really invoke for like 45 days or something like that, right? These are not deeply entrenched. So it's to be determined how this really impacts the different economies, which are in the receiving end of it because we cannot just look at it from the U.S. economy because Honeywell has 50% non-U.S. revenue. So we really have to look at it from the receiving side and how will they react to it.

Yes. No, I certainly share the same view on all those international markets. I guess maybe can you talk about the pricing environment? Tariffs, we saw the latest 232 go higher. Does that impact Honeywell's gross tariff expense? And just any commentary on the pricing environment? And do you think it's harder to get price today than maybe it was in the spring and maybe just excluding Aero on all that?

Yes. I mean, look, we've learned a lot during our pricing cycle of 2022 when inflation hit us on our face and we all kind of rushed through price raises. So I think this year, our approach has been how do we protect our margins while we protect our volume. And when the tariff discussion started coming, we basically went to our customers and said, what's your suggestion? Rather than saying we want to do price increase, and most people then agree, I think some price increase is necessary. So I think our approach to that has been -- we have been able to protect our volumes because what we have learned is that longer-term volume sustenance is more critical even there's a lag in pricing by 1 quarter or 2 quarter, like in Aero example. Yes, you can -- you may have some margin pressure for 90 days. But if you protected your volume, you will get the tailwinds eventually. So fundamentally, I would say the market acceptance on tariffs is -- there is no real pushback, I would say, if you have the right set of conversation. But I mean, in our calculus, we are also factoring the productivity, which we are getting so that our margins are protected, right? So we are not kind of looking singularly as cost increase by tariff, you have to pass so much that you have to retain your margins. I also have to be conscious our productivity is strong. So I do have that lever. So maybe I need not pass all 100. I'm happy with 80 and that still meets my financial objectives because volume protection is the key here. So I think that strategy is working well. My view is that the inflation -- the industrials typically thought about pricing as 1%, 1.5%, if you're lucky. It's more in the ZIP code of 2% to 3% or maybe 3% and a change because inflation is not only on the materials we say, but labor inflation continues to step up. And I have not seen any data which convinces me that labor inflation will come down. So that's going to remain stubborn, which means that's input to our product development, product cost, right? That's part of the cost, too. So it will remain in the similar zone in 2026. I have not seen anything which convinces me that the direction of travel will be changing. So I think our customers are appreciative. It's all about bringing transparency and being more accommodative when necessary.

Yes. I mean I agree with the point on labor inflation, and it does kind of reinforce what you were talking earlier about the value of efficiency and providing efficiency to a lot of these companies. When you kind of took over in the role, a big focus was to spend more on R&D as a true like organic growth engine for the company. Maybe on the automation side, where I would imagine that, that pays dividends quicker than on the Aero, how soon could we start seeing some payoff on the top line from the R&D?

It's in a way, if you see our organic growth rate was 5% in Q2 and 3 businesses grew at above that rate. So fundamentally, I would say the direction of travel has started. The cycle for us is typically from inception of a product to a commercial scaling is about 18 months. So it's not -- yes, it's not like Aero in which it's 5 years. So I do believe that you will observe the impact of that in different businesses across the board. One thing which I feel confident we have transformed in Honeywell is our ability to drive organic growth through new products. That made us make sure that fundamentals that we are not wasting any money. They are unproductive products. That's kind of table stakes. But really focusing on the right set of ideas, focusing on services and software, taking share in some categories. So I think all that momentum is really building. And we do believe that new product growth is going to be the signature of the new -- of this company.

And you kind of mentioned back to mid-single-digit growth, even with headwinds in Aero, we have some of the growth accretive M&A turning organic, R&D. I guess, what's your confidence that the company can maintain this mid-single-digit growth, maybe not every quarter, but over the medium term?

I mean my job is to create foundations. And I would say that fundamentally, how we are building Honeywell with the 3 drivers I talked about, vertical mix, mining installed base and new products, we are preparing every business to grow mid- to high single. The variable will remain the markets. If markets are normal or favorable, then of course, we'll deliver that. If markets are unfavorable in a cycle, then, of course, that becomes a variable. But fundamentally, the company we are building is towards that because we do believe for us to get attention of share owners, we need to be at least second quartile. And because we want to believe more in multiple secular trends versus just go after one for a long-term basis, and we are well positioned towards that, I believe it.

Well, we're up on time. Thank you so much, Vimal.

Thank you very much, Chris. I appreciate that. My pleasure. Thank you.

A lot of great stuff. I thought it was really encouraging...