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

Well, thanks, everyone, for being here. It's my pleasure to have up next, Vimal Kapur, Chairman and Chief Executive of Honeywell. Thanks very much for being here, Vimal.

Maybe we'll just start off with the broad demand backdrop. I think there's a lot of enthusiasm among investors about the prospects for industrial pickup in the U.S. Maybe any thoughts around what you're seeing on that front? And then on the sort of traditionally strong areas like aerospace demand, any thoughts around that?

I mean demand, I would say, in the U.S. from '25 to '26 as the calendar has turned, we have not observed any significant change. The aero demand remains very, very strong. So we expect another strong year for Aerospace in 2026. The demand for building automation remains, again, strong for us. Industrial Automation business also actually in North America is doing very well. Our challenge is the business has a higher mix of Europe and China content and there, the markets are not as favorable. So net-net, it becomes more flat to slightly negative. But North America is doing extremely well for Industrial Automation. I think the only part of Honeywell portfolio, where we see less demand is in energy sector where the demand for short cycle is at best flat and the process markets, customers' willingness to invest due to various reasons, overcapacity and other drivers essentially that's how we guided the Process segment to be more flattish in 2026. So -- but I mean, if I take the larger picture, there are more positives, very limited negative and the negative being more flattish versus things shrinking.

Great. And as you said, Aerospace and Building seems in good shape. In the other areas, what's kind of the main gating factor you think holding back customer investment?

I think, as I said, in Industrial Automation, our business is now much more around sensing and measurement aircraft, different sectors. And it's much more short cycle business. So it's much more linked to local economy. And as I mentioned, we have an exposure to China, and that's probably not growing. And Europe is more flattish. And if your business has a large exposure to those two geographies, that's basically -- it's much more -- it's not that we have any other drivers apart from that. I think the real change for us is the process market where, at one end, you have a high demand in LNG, on other end -- and also in refining, actually, people are putting more capacity in refining, not in the U.S., but in other parts of the world, but there's no -- there's excess capacity of petrochemicals that is driving lack of any investment and cautiousness across the board on willingness to invest even short cycle and that's putting more, I would say, flattish growth in the Process segment. So to me, it's a cycle. How long will overcapacity remain? Our guide suggests it will remain for all of '26 and therefore, we have guided the way it is. But if things go better, clearly, we will have a better performance in the year ahead.

Perfect. And orders are something that Honeywell historically didn't talk too much about firm-wide. You started to mention it more on the last couple of earnings calls. The very strong orders you had second half of last year, I guess, to what degree do you think those are sustainable into this year? And are you seeing any kind of pattern towards, say, longer-dated orders, which a lot of other companies seem to have seen?

I think the orders trend was very robust in the second half of the year, as you mentioned correctly. And we expect, as I said, I haven't seen any change occurring in '26 so far. Those trends will change. Surprisingly enough, the Process Automation and Technology Process segment, where we are forecasting a flattish revenue, our backlog is up double digit. But the cycle time of those projects actually turn is 12, 18, 24 months. So the turn cycle remains longer and we will see more uplift in the orders there and the revenue there in the second half of the year. But even in Q1, we are expecting another strong quarter for Process Automation and Technology. So the backlog keeps building, but it's more long cycle to your question, are people placing orders more ahead. Part of it is, in some segments, there is a more demand than the capacity. Like LNG, for example, we have booked for next 2 years, probably 2.5 years. So we'll -- it just -- if more demand comes, then we are booked for like 3 years, as we just keep pushing to the right. But the demand in Aero continues to be strong, demand in Building Automation continues to be strong. So long-cycle demand remains very, very robust. It's a short cycle, which we talked earlier, has some bit of variability either by the end market or geography in particular, China.

Great. And if you look at kind of the cadence of sales growth through this year, first quarter starts a little bit lower than the balance of the year. I guess, what's the confidence that the sales growth picks up the next few quarters? How much of that is already in backlog and that type of thing.

So most of our -- I mean, I think typically second half tends to be slightly bigger than the first half. That's very traditional. So this year guide is not substantially different. I think the only difference is that in the Process segment, we have forecasted higher revenue in the second half versus first half. That's because we have a higher backlog. These are all firm projects. These are not wins. These are purchase orders and the timing of their execution is in Q3 and Q4 versus Q1 and Q2. So I don't see in the guide. So I think the guide if you see 3% to 6%, the variability here will be how some of the short cycle will perform. And if short cycle remains stable, the way it was in '25, then we have a scenario here on being on the upper end of the guide. If things become change and different in some direction, then we will be in the lower end of the guide. Obviously, we are working hard to be in the upper end of the guide. We're not going to stop there. So repeating 2026 -- 2025 revenue growth is possible, and we have guided that. I mean we are not saying that's not possible. But 45 days into the year, probably too early to put your hands on to it and give a firm commitment.

Yes. And when we think about the cost and price environment, how easy is it to pass on higher costs to customers? Is there any kind of price fatigue that you're seeing in customers?

Look, one thing which probably will all have to internalize is that industrial economy has become high inflationary now. This is -- '26 will be the third year in a row in which we are talking of the price of the order of 3%, maybe even 3%, 4% range. We did that in 2025. We did that in 2024. So we will be doing in 2026, yes. I mean I don't see any concern. But my foundational concern is that longer term, industrial markets have become more inflationary. Honeywell buys 3 broad things: electronics, commodities and labor. Electronics cost is going up with a shortage of semiconductor, memory that obviously increases input costs. Commodity prices keep going up due to constraint while there's a lot of commentary on rare earth, but price of copper is going up, price of zinc is going up. We use our precious metals in manufacturing of catalysts. Those prices have gone up by 75%, 100%, and the labor cost is going up. So what we really -- what I really think about it is that how you deal with that in a 3- to 5-year horizon versus 2026. 2026 will just pass through. But 2027 and '28 is ahead of us. So how should we think about it? So fundamentally, we're doing 3 things differently. First is making inflation and pricing as a constant dialogue with our customers and our channel partners. I don't remember, I've been working for nearly 4 decades. We don't go and meet with a customer and start talking about inflation. That's not -- you talk about your business and your next product and opportunities. And now we talk about inflation as a standard. It helps to condition the whole system. And it allows us to have a step-based approach to pricing changes, so nobody is shocked. So that's certainly a change. Second change is that how we manage our elasticity. It means that while inflation is a reality, productivity has to play and how we make sure that productivity offsets inflation so that we have optionality of pricing to maintain our volumes, because if you have to grow in the upper end of our 2026 guide to 6%, I need 3% volume, and that volume protection has to happen through elasticity analysis. So certainly, there's an element of that sophistication, which has entered into our operating model. And last but not the least, which is very important, is how we create new products, which create more value. So the pricing is less of a dialogue because I'm creating more economic value, the outcome is creating more opportunities for my channel partners, my OE customers or my end customers, they're less debating on this is 5% expensive than the previous version because they are saving money, their revenue is increasing. So new product has to become a much more integral part of the equation. So there is no real -- I think the operating model essentially has evolved compared to what it was. And I do believe that inflation is very, very sticky. It's very stubborn. I have no data point to tell you in '27, it won't be another 3% or 4%. It's just foundational elements are not going to change. Therefore, we have to be far more proactive to think about '27, '28 today versus thinking about it at the close of the year. And we're getting more sophisticated about that.

That's interesting. And on the point around new products is one way to push price and innovation. There's often a concern among investors, in the past, did Honeywell underinvest? Does it need to step up investments to get more new products and take share back? Kind of what are your thoughts around that in Aerospace and in the automation company?

No, I think that's something which is definitely a perception, which we have been trying to -- specifically for Aerospace since the Paris Air Show, we've been trying to showcase the data that our R&D spend is actually at a median or above median of the industry. And we did have some course corrections in 2025 on R&D spend. So we are much more levelized now. Honeywell is like close to 5% now, 4.8%, 4.9%. So we are already above median for automation and for aerospace. So we don't have to rerate ourselves to spend more money. However, we have to spend that money wisely, just because you have the right amount, it doesn't mean you will give the right results. But fundamentally, from a financial perspective, we are in a good spot. And you would not see any change in our margin rates in 2026 because now we're investing further more in R&D. I think that stabilization has occurred. If any, it will be a minor 10 basis point bouncing around here and there, but nothing material moving forward.

And when you think about the automation side of things in particular, you mentioned inflation pressures could be here for some years. Are there things you're doing differently on the cost base now as you think about the next few years? There will be stranded costs from the spin, but maybe some other measures as well.

I mean the stranded cost is the nature of any separation. So that's a reality. And our goal is that the stranded cost is taken out in about 12 to 18 months from the date of separation, which will happen in Q3. So this time next year, I should be reporting to you that stranded cost is almost done or will be done shortly. So I think we already have a plan, but we cannot execute the plan because we are still one company. So it's a little bit of a challenging task that you can't take people out just because you think there's a stranded cost ahead because you're still $140 billion business as it exists today. More forward speaking, I would say that RemainCo Honeywell Automation, which I will lead, our corporate cost will not be any different as a percentage of revenue, what it is today. So we are working towards that stranded cost elimination, which will happen, I would say, 12 to 18 months of time. So I don't see that being a headwind or a tailwind either way. I think it's just going to be a transitionary period in which it will just get eliminated. Longer term, cost has to play an important role in margin expansion. And we need to watch to make sure that the margin expansion levers, the cost the fixed cost leverage remains an important element. And certainly, using more and more tools like -- I think AI is a great tool to drive productivity and how we use more of that into our operating system, into our operating model and that productivity then helps us to keep our fixed costs flat, but also gives us leverage on pricing. That has to be an important element of it. So I'm a big believer of keeping fixed costs fixed and volume leverage should then show up in terms of the pricing gain or margin gains.

And when we think about that kind of margin expansion entitlement at the automation company, is it sort of similar to that 50 bps or so annually that Honeywell itself has often talked about?

Yes. I mean, look, our goal will be that as a RemainCo, we have to compete for shareholder retention with others. So we need to have an earnings growth, which is compelling. We cannot come and talk about an earnings growth, which is not first or second quartile. We -- I recognize the fact that we are not a singular factor linked company like we're not a data center linked company or a utility linked company, where you have much more broader secular trends. And therefore, we are happy to be second quartile versus being the first quartile, which means we have to be high single digit in a typical year through the cycle without dividend and without any M&A, I'm just saying organically, which defines then the basics of what we really have to do. We have to drive a revenue growth of mid-single. We have to drive margin expansion, something close to 30 to 50 basis points, which gives us a high single earnings growth in a typical year through the cycle. And that's what we are working towards. I mean, if you ask my confidence factor is very high because fundamentally, this is how we are constructed. And -- but of course, there's work to be done as we proceed. And more to come in Investor Day, I'm not trying to set up a guide for what the new company will look like, but more thinking about -- if we do not have a goal, we don't know what we are working towards. So this is our goal. We are working towards this direction. We need to turn that into an actual performance through every quarter and every year.

And you mentioned just while on the subject, sort of the high single-digit organic profit growth aspiration for Automation Co. It will get a good amount of cash from Aerospace upon spin. Any early thoughts on sort of acquisition appetite? You've done a fair number of deals a lot more than in the previous few years since you became Chief Executive. What's the appetite to kind of keep going on M&A?

I mean near-term focus is for us to retire our debt so that we maintain our investment-grade rating. It's critical for us for -- we are A2-rated company, and I and Mike want us to be -- remain an investment grade because that's one of the feature of Honeywell, we want to absolutely protect. So '26 probably is going to be more dominant because we are focused on spin and protecting our credit rating on investment grade. But moving forward, absolutely, I think we'll like to build a great franchise of pure-play automation and create more bolt-on acquisition in each of the 3 end markets we serve, which is process, building and industrial. There's an opportunity in each one of them on the bolt-ons. And we have proven already that all the acquisitions we have done, all of them are performing above economic rate of returns, what we had modeled for, which shows that we are doing acquisitions, which are by strategy. They are very targeted. We know how to operate in those markets. These are not random ideas while acquiring in things like LNG, made 2 acquisitions, made a lot of investment in security. We believe world will have more security threats, whether it's cyber or others. In case of aerospace, we made 2 acquisitions in defense. So everything is looked to certain broad driver, which we believe in. And then we are investing into a property and bolt-on to one of our existing businesses. So I think that fundamental premise will remain. One area where I will do more work is industrial automation. At the exit once we complete separation of the 2 businesses, which are under transaction right now, will become a pure-play sensing and measurement business. And I truly believe that there's an opportunity to create a new category of sensing and measurement in industrials because there's no one large player who exist. It's a fragmented market, and we have already proven in building automation that we can create scale in fragmented market. We want to create the same scale now in industrial automation. We're starting from a good base. We have a $4 billion of sensing and measurement business. That's not small. These are all products which are mission-critical. These are all regulated products. And we like that kind of high quality because it's high-margin business, high cash flow. Now can we add more to our current position in sensing and gas detection, in metering. We have a lot of good positions and leading positions. So that will be one of the focus area that we grow from our current position to go to the next level. But it doesn't mean we won't acquire or to consider opportunities in buildings or in process. But all things being equal, we will be more biased to grow our industrial automation space and make it more meaningful part of Honeywell.

Great. And on the buildings front, as you said, it's grown well above most peers in the sort of 18 months now. Do you think it can carry on growing at a decent rate, assuming no big macro changes?

Fundamentally, what we are doing there is in the business, two very foundational things. First is mixing the business towards end markets, which are growing faster. And the 4 end markets, which are our focus is, one, of course, is data centers. We started from a very modest position. Hospitality, you'll be surprised how many hotel rooms are coming in the world. They are staggering. They're never seen kind of numbers. So that's a big focus for us, hospitals. And then the fourth vertical we talk call is clean tech. It means you need manufacturing environment to make a control environment. So battery manufacturing, semiconductor, you need to maintain humidity and temperature to make the product. So these 4, we're increasing our mix. So that's one -- these markets are growing at high single to low double. So that's strategy one. So more mix of our business increases here, more we will grow. Strategy two is do new products to keep share or gain share. And clearly, the new product strategy is working, and we are broadly gaining share for 5 quarters in a row. Now somebody questioned that if we have been growing high single for 5 quarters in a row, why you guide mid-single? Because you cannot be assuming you'll keep gaining share. So you want to act as a more pragmatic to say somebody will catch up with us and we'll get back to market. But we are putting every action to keep gaining share. And it's a model in which we compete with local players in every market. Building automation, our key players are geographic. We have different competition in U.S. versus Europe versus China. And we have a scale position at a global level while we compete with local players. That model is really helping us to keep propelling our new products to compete effectively. And we'll see. I mean we have guided mid-single-digit plus. The indications are so far that our momentum is with us. And I haven't seen, as I said before, that things will change and -- but we'll see how we perform by end of the year.

Great. And then switching to Aerospace for a minute. I think there's questions around potential margin pressure as you get this ramp-up in commercial OE rates. Does that cause accelerated kind of retirements of existing very profitable aftermarket platforms? So maybe any thoughts around the margin pressure there, particularly as you sound more confident on Aero margin expansion now than a year ago?

Yes. So we have been bouncing around 26% margin rates for the last 2 years. I think this year, we believe that margins will move up in range with the Honeywell guide. And essentially, there are 4 things which are changing in the business now through the cycle. OE mix is [ more ] normalizing. We had outsized OE mix. So our OE mix is synchronizing with the growth rate. So still 9% or 10% growth even if you take high single digit, OE mix is not more 15% or 20% growth. So that's normalization of that. That's factor 1. Factor 2 is just a mathematical. We did acquisition, large acquisition. It had a negative impact to the integration cost that's behind us. So that's simply a math. Third is supply chain cost has peaked out. And as volumes keep growing, now we will start slowly seeing the volume leverage, even though not substantially, but it's no more a headwind, which was a headwind for '23 and '24, even part of 2025. And last but not the least, we had lagging effect of tariff in 2025. Aero industry has long-term contracts and OE contracts do not allow price pass-through that will become less of a factor in 2026 because of the renewal of the contracts and others. So I think as you start adding these factors together, things are -- the headwinds have become neutralized or slightly tailwinds. So we will see margin progression in '26. We'll see margin progression in '27. So business is set up, I mean, for high single-digit growth and a small margin expansion every year for next several years ahead of us. So it's extremely well positioned.

And when you talk about the programs on the last point and the inability to pass through, so you wait for the program renewals, kind of how -- is it possible to scale how important that program renewal element is?

It is. I mean, we are negotiating as just a matter of natural course, our OE contracts both in commercial and business jets come for renewal. So we have several of those under works in 2026. But large impact of that will be observed from '27 onwards. There will be some favorable impact in '26, but larger impact from '27 onwards, which gives that was the point I'm making, while we will expand margins in '26, but '27 again. So the fundamentals are becoming more favorable. We had a unique position of a lot of headwinds coming together, and those headwinds are neutralized or becoming more of a tailwind now, this being a tailwind in this case.

And people often ask ahead of spins around kind of stand-up costs and that type of thing. How confident are you that Aerospace will be set up with stand-up costs that are sort of reasonably measured?

It will be in parity with the rest of the market. We have basically said 150 to 250 basis points in that range. Obviously, we want to do at the lower end versus higher end and that will be known when the spin is created. We do not see the stand-up costs creating any disadvantage for Aerospace. Fundamentally, it will be in line. And we have most -- we announced all the leadership team for Aerospace. So that's done. We are actually doing this week, the larger Honeywell [ Org ] announcement of separation between Aerospace and rest of Honeywell because that work has to start, right? And it's a machine -- people have to be told what's your new role. So actually, we're doing it as we speak so that people are prepared for what's coming ahead of them. So yes, but we are confident that the cost basis will be in parity with the market. It will not be either a tailwind or a headwind.

Great. And then when we're thinking about a couple of other kind of spin-related elements, the apportionment of kind of a pension between the 2 sides. And then any differences around free cash flow conversion or free cash margin that you'd emphasize?

The pension will be -- Honeywell pension is overfunded by nearly 40%. So we are going to equally separate the pension. It's equitable distribution between the 2 entities. So it will evenly split. Net of pension income, which is noncash, both businesses are high 90% free cash flow conversion. I mean I'm very confident about Automation. It's a low CapEx intensity business. And we -- our investments are more organic in R&D, et cetera. But Aerospace is also very well positioned because the inventory cycle peaking. '26 will be the first year when inventory actually will reduce after probably 4 or 5 years. Now our days of supplies have reduced because our revenue has increased, but absolute dollars inventory is also becoming favorable, which [ begs ] well for the free cash flow conversion. So I mean, short answer is both businesses are well positioned for 90% free cash flow conversion, 90% plus the noncash income of pension.

Fantastic. Well, unfortunately, I think we have to move now away from the Q&A towards audience response questions. So if we could bring up the first question, please, just on current ownership of Honeywell shares. So 80% no for the time being. Second question is around general bias or attitude to Honeywell at present. So slightly positive starting point. Next question, please. This is around kind of through cycle EPS growth. Is this for now for total company against broad industrial peers? So kind of in line with the peer set. And very quickly, Vimal, on that point on, say, Aerospace growth, how do you think about organic growth there as the sort of medium term in type of...

High single-digit, I would say, through cycle. The demand is so high. It's constrained. It's -- I wish there is a business in which you're constrained by supply side and not by demand side. It's a massive challenge. We have been growing our volume by double digit for like 15 quarters in a row. But -- so that's a good news. The bad news is they have to do for 15 more quarters in a row, and it's just hard, just making so much products, physical products. These are large APUs and engines and avionics. These are not easy to make products. So -- but I think a very capable team, and they will deliver on that growth.

Perfect. And then next question, please. What should Honeywell do with excess cash? So this leans more towards the automation company post spin? Okay. So it's a bit of a mishmash. I suppose, debt paydown and internal investment. And then I think the penultimate question is around the valuation. So the next question, please. Where should I guess, total Honeywell for now trade on this year's earnings? So around kind of 20x, it seems. And the last question is kind of why -- what's the biggest factor holding back your view of why it doesn't deserve a higher multiple, let's say? So organic growth, the biggest question, presumably at RemainCo. Great. Well, with that, thanks very much, Vimal for being here.

Thank you. Julian.

Thank you. It's lovely to see you again.