Cramer's Investing Club: Snap up cheaper shares of Honeywell for its strong pricing power

Published Thu, Feb 3 20223:24 PM ESTUpdated Fri, Feb 4 20224:58 PM EST

Investing Club holding Honeywell (HON) reported mixed fourth-quarter results before the opening bell Thursday. This was a release in which conference call commentary and a nuanced understanding of the environment will reveal far more information than either the reported results or the forward looking guidance. Bottom Line While the headline results were mixed and guidance disappointed, the underlying fundamental strength remains intact. Thanks to aggressive investments, both organically and via acquisitions, in areas such as automation, sustainable energy, quantum computing and advanced building technology, Honeywell is in a strong position to grow both companywide sales and segment income as we and move past supply-side constraints into a more normalized operating environment. Honeywell's pricing power cannot be overstated. Despite supply constraints and inflationary dynamics that characterize the current macroeconomic backdrop, Honeywell has been able to take swift action on pricing, expand segment margin in the reported quarter and expects further expansion of segment margins in FY2022, net of inflation. As a result, we reiterate our 1 rating and would be buyers of Thursday's weakness in the stock price if not for current restrictions. That said, given the supply-chain headwinds that we expect to be with us for at least the first half of the year and uncertainty regarding the path of inflation, we are reducing our price target on HON to $235 from $260, representing just under 27x FY2022 earnings estimates. Companywide Results Revenue of $8.657 billion (-2% YoY organic) in Q4 missed expectations of $8.731 billion. Additionally, while adjusted earnings of $2.09 per share outpaced expectations of $2.08, segment margin of 21.4% (+30bps YoY) came up short versus the 22% consensus. On the call, management attributed the margin expansion to strong pricing actions taken during the quarter to address the headwinds from inflationary pressures and supply chain disruptions. Cash flow was a bright spot as Honeywell generated operating cash flow of $2.663 billion and free cash flow of $2.593 billion, exceeding expectations of $2.536 billion and $2.278 billion, respectively, and resulting in conversion rates of 186% and 178%, respectively. Looking for a moment at full year dynamics, speaking to the strong demand Honeywell is seeing, management called out double digit organic order growth in orders across the company and a 7% increase in the backlog to $27.7 billion. Finally, one of the reasons we have long favored Honeywell to other industrials is it's strong balance sheet and robust cash flow, which combined, provide management plenty of capacity to return capital to shareholders while investing in longer-term growth initiatives. Once again demonstrating management's commitment to investing in high-return opportunities while rewarding shareholders via buybacks and dividends, the team deployed $8.5 billion of capital this year, marking the highest level in the last six years. Guidance Looking ahead, management provided both first-quarter and full-year 2022 guidance. Starting with the first quarter, management forecasts sales of $8.1 billion to $8.4 billion, missing expectations of $8.65 billion. Earnings guidance also missed the mark with management expecting earnings of $1.80 to $1.90 per share versus expectations of $1.97 per share. In addition to the weak topline guide, the lower-than-expected earnings guide can be partially attributed to a weaker than expected segment margin guide, with management forecasting segment margin to come in between 20.6% and 21% versus a 21.2% consensus coming into the print. Full-year guidance was also weak versus expectations with sales guidance of $35.4 billion to $36.4 billion coming up short versus the $36.654 billion consensus and earnings guidance of $8.40 to $8.70 missing the $8.90 expected. Regarding the top line, while it did miss expectations, that target represents organic growth of 4% to 7% — or 5% to 8%, excluding the impact of a decline in Covid-driven mask sales. Additionally, segment margin is expected to come in between 21.1% and 21.5%, short versus the 22.3% the Street was looking for — though representative of a 10bps to 50bps YoY expansion. Excluding the impact of Quantinuum — a previously announced business combination between Honeywell Quantum Solutions and Cambridge Quantum — segment margin is expected to come in between 21.4% and 21.8% (+40bps to 80bps Yoy). Free cash flow is expected to come in between $4.7 billion and $5.1 billion ($4.9 billion to $5.3 billion ex-Quantinuum), also short versus the $5.9 billion consensus. Notably, organic growth is expected to accelerate in the second half of the year. Assumptions making up the full year guide include: High single digit organic growth in Aerospace driven by a continued improvement in commercial flight hours, strong original equipment demand, and stable defense budget spending High single digit organic growth in Honeywell Building Technologies driven by an ongoing return to public spaces that will drive demand for Healthy Building solutions, stable non-residential construction spending and increased infrastructure spending Mid-to-high single digit organic growth in Performance Materials and Technologies driven by order strength in process automation, energy market spending and an increase focus on sustainability and efficiency that is driving investments in sustainable technology solutions. Roughly flat organic growth in Safety and Productivity Solutions driven by strong demand in productivity solutions and services, advanced senses technologies and gas detection. Intelligrated is expected to be largely flat following 50% growth in 2021 as the team shifts its focus from growth to profitability. Lower Covid-related mask demand will represent a headwind to growth in FY2022. Importantly, addressing the inflationary environment we are facing, management commented on the call, "these swift pricing actions allow us to stay ahead of the inflation curve, driving a 5% increase year-over-year on top line and yielding approximately 50 basis points of margin expansions net of inflation." Segment Results While we are providing the high level segment breakdown below, what these results don't reveal is that during the quarter, Honeywell saw double digit YoY organic sales growth in the commercial aerospace aftermarket, productivity solutions and services, advanced sensing technologies and recurring connected software businesses. Aerospace Sales: $2.896 billion vs. $2.852 billion expected Organic Growth: -3% YoY Operating Income: $839 million vs. $776 million expected Segment Margin: 29% (+140bps YoY) Honeywell Building Technologies Sales: $1.404 billion vs. $1.416 billion expected Organic Growth: -1% YoY Operating Income: $296 million vs. $323 million expected Segment Margin: 21.1% (-30bps YoY) Performance Materials and Technologies Sales: $2.605 b