We're changing our Honeywell price target after a mixed quarter and conservative guidance

Published Thu, Oct 26 20232:01 PM EDTUpdated Thu, Feb 1 202411:21 AM EST

Shares of Honeywell (HON) were under pressure Thursday after the industrial conglomerate reported disappointing third-quarter results and weak forward guidance. While earnings and cash flow came in slightly ahead of expectations, there wasn't much else to get excited about for the rest of the year. Revenue ticked up 2% year over year organically to $9.21 billion, shy of analysts' expectations of $9.23 billion, according to estimates compiled by LSEG, formerly known as Refinitiv. Adjusted earnings-per-share of $2.27 advanced 1% annually, edging out the consensus forecast of $2.23 a share. Segment margin, similar to an adjusted operating income margin, grew roughly 80 basis points to 22.6%, a slight miss but equal to the high-end of management's guidance. HON YTD mountain Honeywell YTD Unfortunately, Honeywell hit a 52-week low in Thursday's terrible market. The stock has dropped nearly 18% year to date compared to the S & P 500 Industrials Sector 's nearly 1% decline in 2023. Bottom line Thank goodness for aerospace, the only segment to outperform expectations with double-digit organic growth on a percentage basis in both commercial aviation as well as defense and space. Outside of that, and slightly better-than-expected cash flow, the numbers were not that inspiring. Moreover, guidance for the remainder of the year was mixed: Sales are expected to be better than we thought. Earnings and free cash flow forecasts came up a bit short at the midpoint (though did bracket expectations). We would note that Honeywell has a tendency to report results at the higher end of previously provided ranges. So, why stick around after a quarter like this? Because, while end markets remain choppy, things are improving as we head into 2024 and the stock trades well below its 5-year average valuation based on both price-to-earnings and in terms of the annual dividend yield, which currently stands at around 2.5%. Cheap stock, plus improving fundamentals and end market dynamics, equal opportunity. Regarding the improving fundamentals, Honeywell's backlog reached a new record advancing 8% annually (3% sequentially) to $31.4 billion. Management said orders are "reaccelerating as demand generation improves" and that "demand continues to outpace output in Aero." Wall Street estimates aside, we got nearly 80 basis points of segment margin expansion (and management expects that trend to continue), thanks to continued improvement in the sales mix and the supply chain which is key to converting that backlog to actual sales. We're also seeing demand in key areas start to bottom out. While the timing of an inflection remains uncertain, we see it happening in the next few quarters. We would rather be patient than try to hop out and time when to get back in. Further signaling confidence to investors that things are set to improve and that the stock represents a bargain at these levels, management ramped up its buyback activity during the quarter. Honeywell repurchased 5.3 million shares during the quarter, more than double the amount purchased in the second quarter. Management noted that it was "due to highly attractive valuation and our ongoing confidence in Honeywell's performance." As a result, we're reiterating our 1 rating . However, we are reducing our price target to $210 per share from $225, representing about 21 times 2024 earnings estimates. That's in line with the average multiple we have seen over the past five years. Quarterly commentary As seen in the earnings table above, better-than-expected Aerospace sales in Q3 of roughly $3.5 billion were the bright spot in the quarter with management calling out "double-digit growth in both Commercial Aviation and Defense and Space, the strongest growth quarter for Aero in over a decade." Though supply-side dynamics are improving, demand continues to outstrip supply with the segment's book-to-bill ratio coming in at around 1.3 for the quarter. Remember, a book-to-bill ratio greater than 1 is a good sign of high demand. Performance Materials and Technologies sales of $2.87 billion were led by process solutions, "which saw double-digit growth for the fourth consecutive quarter." The petrochemicals business known as UOP saw growth was "led by gas processing solutions and petrochemical catalyst shipments," with management adding they continue to see strong demand in the sustainable technology solutions business as "orders grew triple digits for the third consecutive quarter, and sales grew at strong double-digit rates." Safety And Productivity Solutions remained under pressure, with Q3 sales falling nearly 30% to $190 million, due largely to lower volumes in the warehouse and workflow solutions, and productivity solutions and services sub-segments. Regarding productivity solutions and services specifically, management noted that they believe we are nearing the end of the distributor destocking cycle, so we'll be on the lookout for improvement hear going forward. Honeywell Building Technologies benefited from 4% annual organic growth in building solutions which was offset by a 3% organic decline in products. Building solutions sales of $382 million results were driven by growth in building projects, with management adding that "orders for building projects were also substantial in the quarter, up nearly 20% year-over-year and resulting in a book-to-bill ratio of approximately 1.2." Guidance On a full-year basis, versus mangement's previously provided forecasts, these targets, as seen in the above table, represent a slight decrease at the midpoint for sales and organic growth; a slight increase at the midpoint for the segment margin (as the lower end of the guidance was increased slightly); and no change at the midpoint for earnings and free cash flow. On the table, you can see how both the full-year and the fourth quarter outlook stacked up against estimates. Additionally, for both the full year and the current quarter, earnings performance is being suppressed by pension liabilities. This amounts to an expected headwind of 14 cents per share in the fourth quarter and 55 cents per share for the full year. The full-year outlook came up short at the midpoints on earnings, and free cash flow, however, the ranges provided for earnings and cash flow did bracket estimates — and given management's tendency to report results near the higher end of previously provided ranges, we still think the estimates are achievable if not beatable should the economy remain resilient into year-end. Looking to 2024, though management hasn't yet provided a quantitative outlook, it's clear they are optimistic that fundamentals will continue to improve, calling out "fleet growth and replenishment" in the aerospace sector, tailwinds from automation and infrastructure investments, the ongoing energy transition and "continued strength in digitization". Qualitatively, continued volatility is expected but management believes they can deliver further growth, margin expansion, and cash growth "in line or above EPS growth." Moreover, the team sees a "robust M & A pipeline" and called this out as a focus area for capital deployment. Finally, it's a couple of quarters off, but we'll be interested to see how new Honeywell CEO Vimal Kapur's reorganization plans develop next year. The new segments, which will take effect at the beginning of the first quarter of 2024, will be Aerospace Technologies, Industrial Automation, Energy and Sustainability Solutions, and Building Automation. (Jim Cramer's Charitable Trust is long HON. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Honeywell International Inc. signage is displayed on a monitor on the floor of the New York Stock Exchange (NYSE) in New York.

Michael Nagle | Bloomberg | Getty Images