Honeywell International Inc. ($HON)

I think before we kick it off -- the conference off, I thought I'd make a few other remarks for those of you who don't know me, my name is Nigel Coe. I lead coverage of the U.S. Industrial sector here at Wolfe Research. And it's my pleasure to welcome you to the -- first of all, on behalf of Scott Group, Males Walton, the sales team, [indiscernible] teams and also our founder, Ed Wolf, I do -- I want to give you a warm welcome to the 19th Annual Wolfe Industrials and Transports Conference. I used the word warmly because today is going to be a warm one. Tempature outside today is going to be over 90 degrees. The first day in New York overland degrees this year. So what a great day to be in the small confined room with 400 people. So far, the air conditioning is working because some cold air coming through and a long way that continues. So as you'd expect for a U.S. inductors conference, we're going to be running the AC really hard. We're going to have CEOs on the stage, and we've got a AC coming out of the band. So we'll endeavor to keep you guys as cool and comfortable as possible. We've got another really great lineup of corporates this year. We've got 106 corporates attending for one-on-ones presentations. We've got 577 investors registered, and we're hosting 526 one-on-one meetings. So that's a really good lineup. New records for the conference. And I'd like to really thank all of you for both corporates and investors for sporting this conference. It's not easy to pull it off. So I do want to say a big thank you to our corporate access teams for really just the dedication and hard work of making sure all the logistics line up. And finally, I do want to just remind you, we've got a cocktail event this evening, kicks off at 5:00 p.m. I would love to see as many of you there as possible, just to mingle in a sort of very casual environment. 5:00 p.m., but we'll see if we can get the bar crack open a little bit earlier than that. So that's it for my prepared remarks. Once again, thank you for being here. And yes. Okay. We're going to start. It's 8 a.m. So it's time to get into the conference. And it's -- I've got 4, 5 far chats to kick off the conference, and it's my great pleasure to welcome Honeywell. I can't think of if a better way to start the conference than with Honeywell. And it's my pleasure to welcome Mike Stepniak, CFO and SVP of Honeywell at the stage. And Mike, thank you for being here.

Thank you. Thank you for having us today. Appreciate it. Good morning, everybody. Maybe before we get to Q&A, I'll just give you a quick update on what's going on in Honeywell, where we're at. But as we announced separation will take place on June 29, that's the first day of the third quarter. We are in the final stages of separating, I would say, all green lights as far as a go Aero Analyst Day, just once again, it will be in Phoenix on June 1, and there will be a couple of events on June 2. There's a preload to that. And the Analyst Day for RemainCo will be here in New York City on June 11. So obviously, everybody is welcome, and we have great events lined up operationally, things are going well. We'll talk about it today. But I would say, obviously, we're reconfirming our forecast for the year and the guide and a lot of, I would say, positivity in the markets generally. .

Great. Thanks, Mike. We're going to spend today talking predominantly about high automation, I think, -- but you mentioned all green lights for the spin. Any remaining hurdles to cross here? Or are you pretty much good to go at this point?

We're clear to go. They're obviously all the way to the end, there are some activities and postspin, you have some transitional services, TSAs, things like that. But operationally, we're ready. So I don't foresee any issues as far as the 29th.

Great. That's good to know. This hasn't exactly been a huge amount of time since you reported results, but we are 2 months into the quarter. Anything to comment in terms of moving pieces around the portfolio, particularly interested in this Middle East headwind that you're...

So maybe I'll address that first. Middle East is resilient. And it's -- I would actually say it's better than what we thought it was going to be. Customers are extremely active. We already sent our teams to the region, including -- all 3 of our general managers have been visiting customers. So words are on the way as far as repairs, et cetera, underlying demand is still there. So I think we said $100 million to $150 million pressure in the second quarter. that's looking much better. It's going to be way up $100 million and customers from an order activity I see customers not only in for repairs, but also thinking about the future expanding, et cetera. So really good demand, I would say, coming up in the midterm from the region.

Okay. And anything else to highlight across the portfolio?

Sure. So maybe I'll just go through of our segments, Building Automation see strength across the board. And as you know, they've been printing high single digits in the last 6 quarters. we are guiding them in single-digit plus based on everything I see in the second quarter, though we have another outstanding quarter. So that portfolio is performing extremely well. Industrial Automation for us has been a story of self-help. And with Pilau coming in and applying some of the knowledge transfer that he brought from Fire and some of his external pursuits, we're seeing a lot of improvement. And we also see green shoots in terms of underlying market. So I feel like the business stopped losing share and starting to gain share and will be growing into the second half. So a lot of positivity there. And obviously, transformation of the portfolio is helping us a lot as well. And then on Process Automation technology, that's a business that has been facing pretty hard dynamics. In the second quarter, they're lapping pretty tough comps from last year. but they're sitting on the record backlog and they'll have another outstanding quarter from order standpoint. There is a significant inflection coming back into the second half that we talked about and we have a strong visibility to that volume and orders are extremely, I would say, are picking up both on the catalyst side now on the short cycle and from the projects. our LNG business is sold out now for 3.5 years. So really good, I would say, tailwind going to the second half. Now I'll remind you that second quarter is a tough quarter for the business. So that's not changing, but we're seeing a lot of inflection in the second half.

Okay. And the backlog, does that give you confidence in that inflection? Do you have that visibility? Or is that more beyond this year?

This is the second half of next year. So it's a very high-quality backlog. What I mean by the waste project is going to FID. When they go to FID, we start work. So the teams are starting work because they have financing. And then we're having a lot of discussions now with customers on catalyst. So that interest is going to lead to orders as well.

Okay. We talk about projects. Obviously, LNG is what we have in our minds mostly. But what else beyond the LNG are you seeing that?

Look, I mean, U.S. doesn't talk about ESG a lot. We were just last week in Europe. ESG in Europe is quite a life. There are a lot is going on, a lot of interest same with Latin America and Asia. I think there's this disruption that happened here in Iran reminded people how fragile the whole ecosystem is that the people are looking for energy security and I'm confident these projects are starting to come back. We had a couple of projects go FID in the second quarter, predominantly in Latin America, but we see HG coming back.

Yes, ESG, not quite that yet.

I think, is going to be resurrected.

But you think so. And then going back to Build Automation. You mentioned another, I think, the word was outstanding quarter from Build Automation. Yes. Maybe just take a step back, we're not seeing too many of your competitors growing at this level. Maybe just unpack what's driving that growth?

We did several strategic shifts over the last couple of years in the building automation in the business. One, we moved many of our teams and the focus in region for region, where we can be more intimate with our customers. We revamped very early our NPI machine and R&D. We talked about it last year. We reinvested into our R&D, and R&D was about 50 bps of margin pressure for us last year. That's about $350 million across the company. Just last year alone, our fire business had over 30 NPIs come to the market. And Forge is a big deal for us as far as connected and driving the connected offering Bela and Suresh talked about earlier in the year, but this is really taking off for us. So we see growth in our verticals. and we'll continue to pivot to high-growth verticals for us, which is, for us, it's life sciences, it's hospitality, hospitals, data center as well, although data center is still fairly small for us, but we're seeing growth across the board.

If you had to rank order the NPI versus Forge as a driver of that growth, enable that growth, would you say one is more important than the other?

So really, NPI is all about just installing your creating installed base and growing our installed base, where I see most Forge opportunities for us is moving really to automomous operations. which for us, a lot of it is in the aftermarket. If you think about technicians retiring, not having people to come to service buildings or whatever facility you have, that's where really connected comes in, that's where Forge comes in. that's where cognition comes in, where you can run and operate facilities remotely with fewer people. And that's where we see the benefit of Forge coming in.

Now Forge has been around for quite some time, but I think it's now starting to reflect. And I'm just wondering, is AI starting to enable some tools that customers are now seeing real value?

Yes. So AI, I think, is alive, obviously. I can tell you in Honeywell, we are deploying a lot of AI on the cost side. For us, this is really a productivity tool. And you have to be able -- in order to be effective in it, you have to deploy that scale. So you need really processes that are scalable and at scale in order to apply those tools and be cost effective for you. And that's what we're doing from Honeywell standpoint inside the company, if you think about how we are curing NPI, how our engineers work a lot of the perm processes, USA. On the commercial side, for our line of work, it's a little bit different. You can just come in and take an AI from Street and apply it into a process plan that you have very strict, I would say, operating parameters, and you have 40, 50 years of domain expertise in terms of how we design these. So where we're deploying right now, AI is really just for forge and really focusing on our domain expertise and which is around controls and critical operations.

Okay. But in terms of Honeywell the way you operate Honeywell. You're not seeing big displacement of traditional roles by AI at this point?

No, we don't.

No. Okay. Okay. Aerospace, I do want to just touch on maybe just going back to 1Q, the supply chain issues that you saw, obviously, growth was well below what you expected. -- maybe just brings up to speed. Well, maybe first of all, just maybe just run through where you're seeing the barriers on the supply chain, what you're doing to overcome those and how are we tracking through the second quarter?

I would say maybe first, to talk about the second quarter. So Jim guided mid-single digit to high single digit for the quarter. And I think we'll ever that they'll have their Analyst Day in a couple of weeks, they can talk more about it. As you know, the quarters in that industry are very back end bolted. So it's really the last month of the quarter where you get a majority of your output. And I think that's what the team is instrumenting. Everything I understand April was encouraging. So it's definitely will print better results than in the first quarter, but they still have some work to do. As far as the supply chain issues in aerospace, specifically related to Honeywell, it's on the mechanical side. On the mechanical side, we -- I remind you that the business produced 14 quarters in a row, double-digit output growth from factories. -- first quarter, I think, was unusual, and the team got surprised with few late-stage de-commit from the suppliers. They're working through that. But the supply issues, how they continue. We've done a lot in terms of investing in our own supply chain. We've done a lot in terms of investing in our suppliers as far as tooling testing, et cetera. But right now, the capacity of the supply for us, it's about 10% to 12% year-over-year growth. And we really need something like 15%.

Okay. It seems like it's a lot of the smaller links in the supply chain that's where the pressure points are.

That's right. And that really comes to the nature of the mechanical supply chain. It's more fragmented. It's smaller players. Some of them are not well capitalized, et cetera. So you have to assist them or you have to in-source it, et cetera, as a team is kind of working for that.

Okay. I mean, say mechanical, is it mainly on APUs and engines? Or is it...

It's more engines more engine pronounced. It's forgings, castings, plates, things like that.

Okay. Okay. Nuts and bolts basically.

Yes, exactly.

Yes. Okay. And maybe just before we move on to set some of the separation items to consider. Industrial Automation, maybe just bring us to speed in terms of the timing for the PSS and warehouse exits. And then maybe just a remind us what's left in IA at this point. We know they're sensing there's smart meter there's anything else to think about there?

Sure. So the business will be post DLX, it will be about $3.5 billion. and it's pure play now measurement and instrumentation business. quite excited about it. We have a lot of domain expertise. We have good positions, much more focused. And that's why I'm so confident in the inflection of that business. off from a top line standpoint, but also very important from a margin expansion standpoint. The business right now is quite dilutive to Honeywell. Over the next 2 years, it's going to lead the margin expansion for the company. And you'll see that at the Investor Day and you'll see essentially impact immediately as we go through the second half. So I'm quite excited about the inflection of that business.

And any help you can give us in terms of once we extract those 2 businesses how the margins look for business?

And I would say the businesses are dilutive to overall Honeywell, obviously, but also to IA. I would just ask you to be a little bit more patient with us, and we'll have that information on the 11.

Do you think that can again, this is probably a question for back in June. But do you think these are low to mid-20% type margin businesses because that's obviously where Honeywell is?

That business that we're exiting?

No, no, the remaining IA business.

Yes, the business -- look, I mean, it's -- for the business to earn its keep in Honeywell portfolio will have to be north of 20%. So that's what we're working for.

Okay. Okay. And obviously, $300 million makes a little less scale than the other 2 segments. Is the intention to build -- to refocus acquisition activity within IA?

Sure. So maybe I'll talk about it. And we'll have a we have a discussion at the investor event about how our acquisitions are doing. But when you talk to Pete what you'll see is that within Industrial Automation, we have a lot of white space. And the industry itself is quite fragmented. So there is a lot of opportunity there as far as the M&A, but we obviously we'll be careful to share the assets that we add and when we add them -- they continue to be accretive for us, and we see a strong technology fit. I would just leave it at this. And if you look at our portfolio, process automation technologies are pretty well provisioned with acquisitions. They have a lot to work with as far as organic growth and margin expansion. So as building automation, the Access Solutions business is doing extremely well. We'll be looking at maybe some bolt-ons down the road there. And then the focus is really on industrial automation stage.

Okay. We do still get questions about the possibility of a big bang transformational acquisition within IA. It seems you've been indicating some a bit more maybe creative and maybe I don't know tangent of the word, but where do we stand on that?

That's probably a better question for Vimal when we talk to them. But generally, I think where our head is, is we don't want to bet an enterprise on something being in transformative. We've seen companies that get in trouble with big acquisitions like that. What we find works for us the best is bolt-on which for us it's $2 billion to $4 billion ticket die assets. We tend to know how to absorb them quickly and realize commercial synergies in the best way.

Okay. I'll take 1 or 2 more questions, and then I'll throw the Q&A open to the audience. Maybe just think about the aero separation. You mentioned on track, maybe some TSE agreements to [indiscernible]. Maybe just bring us up to speed on the stranded costs. You said $350 million to $400 million round of costs as sort of the low end of that range, I think, is what you said, but maybe just where do you expect to be on day 1?

Sure. So we thought stranded cost was going to be around $400 million when we look at it in January. We obviously went after stranding costs for a while now before solstice. And by the way, I remind you, sources up 70%. I just want to shout out to the team. They're doing extremely well. We will show up in June with probably less than $300 million stranded cost. And majority of the stranded cost is already being addressed. So meaning it's related to repositioning, et cetera. and we've already provisioned for it as far as executing this stranded cost. So by year-end, I'm assuming right now about $100 million as a cost. Its a really good story. Team really rallied around this. And given we're going through separation, but we're also trying to grow the business, et cetera. I think that's really strong focus from the team on getting the trending cost in the box quickly.

Okay. So just to make sure I understand that. So less than $3 million stranded cost on one of the separation.

On June 29. That's correct.

Right. Okay. That's really impressive. Okay. And then the restructuring actions to encompass that would be part of the acquisition onetimers I see.

Most of it is onetime cost, correct?

Yes. Okay. And then pension. We talked pension with any decisions on pension income?

So for people don't follow our pension discussion is I'd just remind you, our pension is 40-plus percent overfunded, more like 46% overfunded. We're doing natural split on the pension between Airspace and Honeywell. What I mean by that is we're essentially dividing a patient base when employees were an overfunding goes proportionally with that. So Aerospace, where we get about 55% of the pension assets remain will be left with the rest. With that said, we're still having discussions with our Board on what's the best treatment for the pension. There are 2 schools of thought. One is, obviously, you get implicit value for the pension because it is an asset. The second school of thought is quite volatile. It affects your free cash flow metrics. It excuse quality of earnings, et cetera. So we're finalizing the discussion. Obviously, we'll have more to say on the 11th. Do you have info on it?

Just my free advice is free because of sorts worth I do think that free cash flow is the key.

That's correct.

And I think the pension just adds noise personally. I'd be at [indiscernible] on earnings. Not to say it's not clean. But maybe just going back to the pension surplus, you've sort of referenced the possibility of monetizing surplus? Any thoughts on that?

Look, there are 2 different ways you can do it. And I don't want to take a lot of time today on that and people can read it. But if you look at what IBM did or what Kodak did or what Nokia is doing, I mean, those are several different options you can you can structure it in a way where you open in your defined benefit plans, you can straight up exit it or sell it, which -- but it's very tax-efficient. And there was actually One Big Beautiful Bill. There was some legislation proposed where you could find some of your benefits from the, I would say, from the overfunding that in past, but nonetheless, is being discussed -- so maybe it was more about it in the future.

Okay. Great. Enough pension, otherwise, we'll send it on sleep. Any questions from the audience? Any questions for your hand up? Otherwise, I'll keep going. No. everyone likes to just listen to me talk and ask questions. So thinking about quantity, I know there's a Nest or Quantium. I know that you're titin terms of what you can say, but maybe you tell us what can you say about this about the [indiscernible]?

I can't say a lot. I will leave at that. But what I would say is that there will be few announcements coming up soon. As a team is working through flurry steps of its strategic journey as well as commercial journey I'm extremely excited about the commercial progress the team has made a maturation of their technology, and they have a very strong pipeline as far as orders that's going to convert to revenue. which we're excited about. And I think right now, it's the right time for them as they're maturing, growing, et cetera. It's a good time to stand up the company.

And you said publicly the $250 million of investment spend or losses that's now right now in corporate expenses that deconsolidates, is that still the case?

That's right. So right now, we're fully consolidated. At some point, we will not fully consolidate. And we will only -- I would say, from EPS standpoint, won't change anything. But from a segment margin standpoint, it will be a tailwind for us because we will only put above the line, the portion of the company that we own. It will be sub-50%. And today, it's 100%. So simple math. Today, it's $250 million that goes above the line tomorrow, it's $125 million.

So it seems to me that when we think about the $250 million from continuum going below the line, you got the $150 million of royalty income from Aero. You've got the $300 million coming in. It seems that net-net corporate expenses come down on day 1. Is that...

that's right. I mean, structurally, we have a lot of margin expansion. And look, the trademark license is helping us with some of the inefficiencies we'll have as far as simplifying residual taxes, et cetera. And that's temporary too because that's -- I think that cash flow continues for about 5 years. But generally, I think the corporate expenses will be much better. More importantly, we'll be cleaner. We're trying to have a cleaner income statement. And hopefully, you noticed, we also removed our asbestos liabilities last year which was a big drag for us and the tailwind going forward.

Yes. That's great. So my remaining questions are really -- you're probably going to tell me come back in June for the Investor Day. But you've got standing targets for 4% to 7% for Honeywell today. The RemainCo automation business, is that still a decent framework for organic growth going forward?

That's right. I would say it's mid-single digit I think that's how I would position it. I think you'll see us growing more consistently on a go-forward basis. We've cleaned up the portfolio. We have diversified. We -- like I said, we restarted our NPI wheel machine reinvesting to R&D. -- moving purposely to high-growth verticals. Software and services revenue is growing faster than the rest of the business. It gives us stability in the top line as well. I think what I'm most excited about is the margin expansion story for Honeywell over the next 2 years, and we'll talk about a lot during the Investor Day.

Okay. That's exciting, actually margin expansion. So that would be the process marginalization IA?

IA is going to lead process and it's going to better mechanically, just where they are in their cycle. And then building automation continues to innovate and introduce really compelling NPI, which allows us to have better mix, better leverage on volume, obviously, stronger pricing.

Okay. So I'm going to be a genius to figure out that you're going to be pitching double-digit EPS growth for the next 2 or 3 years?

Look, you'll see on the 11.

Yes. But I've got questions here. I did asks questions.

What I would say with this is that our growth will be front loaded. I think that's kind of where the set for us is. So now people discount the year 3 usually. But what I'm excited about is we're instrumenting the company to perform this year and next year?

I think a really important part of the story is the way that you and Vimal have retooled the incentive structure to incentivize investment spending. Maybe just touch on that quickly. So I think that's really important.

Yes. And Vimal is patient in terms of linking pay to performance. And we're actually looking at our plans right now for 2027. He really wants to focus the team on customer obsession and NPI. And NPI, obviously, is also a function of customer obsession. So we're working on KPIs where which we will put into our performance plans for the managed team that are focused on metrics that our customers care about. And obviously, the Street cares about from a growth standpoint. So there's more to come to it. But generally, in the past last few years, we pivoted as far as incentivizing more on revenue growth, and we incentivized center teams within our engineering offering, et cetera, around cross-sell, around NPI Sedo, around offering. And we're taking a step further to put more of the organization under those plans.

Okay. And that wasn't the case before. .

That wasn't the case.

Yes. Okay. I think 1 of the key changes on the Vimal has been much more M&A, much more -- I don't know if aggressive is the word, but certainly deploying more capital into M&A. The balance sheet for automation is in good shape with the dividend. Is that still going forward to be more acquisitive and maybe less buybacks?

I would say this, we'll have -- we'll continue to have a prudent capital allocation framework. And what I mean by it is that what we see investing in growth CapEx. But generally, business is CapEx lighter, I would say, versus it used to be. Second is we'll maintain our dividend ratio, if you will, in line with our peers. We've talked about that. And then we'll maintain our, I would say, share count and offset dilution at a minimum if our free cash flow generation allows and we need to, I would like to get the outstanding shares lower, maybe 1%. That said, all that said is in the short term, we're focusing on debt repayment. And you will see us this year paying down a lot of debt and getting our leverage ratios down to about 3x on the gross leverage for -- before -- at the year-end. As far as M&A, we'll continue to do M&A. Like I said, I think for us, better is bolt-on and tuck-in. And if you look at our cash profile we should be able to comfortably do 1, maybe 2 M&As a year.

Okay. Okay. Of course, we got the Catalyst acquisition still pending?

That's right. So that should hopefully close in the third quarter. We're quite excited about the business. has great market positioning with everything going on in the world. I think this technology has a lot of future and this is -- we're quite excited about it.

You mentioned negotiate down the price as well, which is...

We did -- I mean the business just was in Wharf what we thought the last year, given where the market is. So we're able to renegotiate. and we're just waiting to close it.

It was the case sometimes you buy a company and you realize it's not worth what the stores we don't get the low price. So that's actually well done. I think that covers it. I'm not going tariffs. I want to spend a little time to talk about tariffs as possible. So Mike, I think we'll draw a line there. unless there's any last questions from the audience.

We're around today, so I'm sure there'll be questions.

I'm sure all -- any closer remarks, Mike?

No. Thank you once again, thank you for coming today. We're really excited about Honeywell, both businesses and -- we have some exciting news at respective Investor Days coming up. And both companies have a really good setup, and I think are entering the second half from position of strength.

Thanks, Mike, and good luck with the separation.

Appreciated. Thank you.

Thank you. Thank you.