Honeywell International Inc. (HON) Presents at Barclays Industrial Select Conference (Transcript)

Honeywell International Inc. (NASDAQ:HON) Barclays Industrial Select Conference February 22, 2023 8:00 AM ET

Company Participants

Greg Lewis - CFO

Conference Call Participants

Julian Mitchell - Barclays

Julian Mitchell

Well, I think, we’ll get underway. Thanks very much, everyone, for attending. My name is Julian Mitchell, and thank you for coming to the 40th Barclays Select Industrial Conference here in Miami. It's my pleasure to open the event formally with Greg Lewis, Chief Financial Officer of Honeywell. I'm sure many of you know Greg, and we're looking forward to a good discussion this morning. So welcome, Greg.

Greg Lewis

Thanks for having me.

Question-and-Answer Session

Q - Julian Mitchell

Absolutely. And maybe, Greg, just first off, I guess, looking at the operating system at Honeywell, yes, that's always been kind of at the forefront of how the company kind of runs itself and talks to the Street for the past couple of decades. There have been some improvements with upgrades. It's discussed more as a sort of Honeywell Accelerator now. You've also talked about Honeywell Digital. Maybe give us some insight as to what's changed in that respect.

Greg Lewis

Sure, sure. Yes. I mean maybe just to open it again, thanks for having me. I can't believe it's been -- so much has happened in the year since I was here last with you. The conflict in Ukraine wasn't really underway just yet. And who knows what -- the world is still a bit of a crazy place, and who knows what curveball will get thrown at us this year, but I'm sure there will be one, we just don't know it yet. But I feel great about where Honeywell is, broadly speaking. The macro trends for the end markets that we support are all pointing in a really good direction. Obviously, the interest rate and inflation environment remains a little bit choppy. So we'll see how the broader economy holds up.

But the long term for Honeywell is great and we continue to perform. You talked about our Accelerator operating system, which really underpins our ability to execute, and frankly, outexecute in most every environment. We did that again in 2022 with a year of hyperinflation, where we really executed around price cost for us.

And so the next thing for us is capital deployment. So we're going to keep executing on the organic side operationally and then now pivot more from a capital deployment standpoint. We promised $25 billion over 3 years. We did $8 billion of that last year. Half of that went into share repurchase, and we hope to push more of that into M&A.

What's different with Honeywell Accelerator, it's evolutionary, right? When I stood up Enterprise Information Management in 2017, that was the precursor to Honeywell Digital. We're now 6 years in. We've talked about the great integration of Honeywell and we're on to the next phase. And so our operating system has moved into a place now where we're thinking about it across business models.

So we've got 4 predominant business models in the company, projects, services, products and SaaS. And now we're designing all of our operating rhythms for each of those 4 things and making sure that they get permeated across the company and digitized. So again, using that Honeywell Digital capability that we've now created, and we're really harnessing that across all of our enterprise with those 4 business models in mind.

So it's really inculcating that in a way that's going to make things less human-dependent. And I don't mean that we're going to have robots, but the point is if you think about acquiring a company and then plugging it into Honeywell, if we've got these instantiated processes that are digitized, way simpler to do that with a new acquisition and ensure that it happens properly.

If you think about bringing people onboard and training them as to what we want them to do, coming into any business in Honeywell and knowing exactly what it means to run a projects business, what that operating system looks like, what KPIs we would want them to monitor and manage and have them all digitally available in their own cockpit as a matter of course. It just takes a lot of the creativity out where it doesn't belong, right? There's room for creativity and that's called new product introductions and working with customers on creative solutions to their problems. We don't need a lot of creativity in reimagining how to run the business operating systems and the muscles that it takes to that.

So I would think about it as really an evolution to continue to inculcate that into the business and make it even more sustainable, which I think is adding a lot to our, again, ability to execute in basically any environment.

Julian Mitchell

Understood. And when you think about the guidance for this year, I think there was a view that last year when you set the guidance, it was fairly conservative and subsequent events may have proved that correct.

Greg Lewis

We won't talk about that...

Julian Mitchell

Fair enough. But if you think about the contract behind the guide this year, maybe give us some flavor as to some of the main sort of macro assumptions in that.

Greg Lewis

Yes. I mean the way I would characterize our guidance is prudent, because when you think about it, we've got a couple of engines that we can count on in terms of Aerospace with more demand than we know what to do with and a supply chain that's going to take multiple years to actually recover. So we're going to be on this growth path now for 2 to 3 years that I can pretty much etch into the books. PMT, similarly very strong macro trends around the energy transition. So there, a lot of confidence in their ability to grow.

And then when you think about SPS, we know we're going to be declining this year. That's a matter of fact. Part of that is the whole warehouse automation constraints, if you will. And then HBT is a little bit of a wait and see. We've got a good backlog that carry us through the first half of the year, but then how the back half will shake out remains to be seen.

So that's really what -- when we think about it, people want us to be more aggressive, and certainly we could have made a more aggressive guide and maybe that will come true. But Honeywell, where we are, we don't promise things [are not convicted about]. And we view our guidance as a promise, we're going to make those numbers.

And could it be better? It depends on how the economy shapes up and whether order patterns stabilize or reaccelerate in the products-related businesses. And when that becomes visible to us, we'll either confirm where we are because it worked out the way we thought or we'll change and upgrade if we see things improving.

Julian Mitchell

That's helpful. And when you think about the order trends, what's the sort of the broad assumption? Is it sort of some growth first half and then second half, you'll see...

Greg Lewis

It's likely going to be still good growth in Aero and PMT and probably softer in HBT and SPS. And in the second half, again, if things accelerate on the product side in HBT and SPS, then things may be to the high end or better.

Julian Mitchell

And when you take a step back on the top line and think about volume growth at Honeywell, maybe that's something that investors have found a little bit below maybe what they might have hoped the last year or 2. Maybe give us your perspective on that and maybe the trade-off of that versus cash? And when you look out beyond this year, do you think we can see factors that maybe drive that volume growth higher than the last couple of years?

Greg Lewis

Yes, sure. Listen, when the world becomes normal and there is no such thing as supply constraints in -- because of skilled labor shortage in our biggest business, and when there is not a semiconductor shortage that's stopping 2/3 of the rest of the business from being able to deliver product, and when there's not a war that knocks out 1% of our revenue and when there's not a pandemic that causes us to invest in a mask business that then we have to bring back down again, then it will be normal. And then we'll not talk about some of these weird things and we'll talk about what the strength and the pace of the business is.

And I think -- again, I'm not a clairvoyant. So I don't know what 2023 will bring as far as those things are concerned. But if things normalize, I would expect that 2024 should be really good because I don't see the PMT and aerodynamics changing anytime soon. And if you get general economic recovery on the remainder of the business, then you can imagine a really strong volume story going into 2024.

But again, we'll see. We also thought that there was going to be a rate tightening cycle that was going to stop and come down in the back half of this year, and that's starting to look like maybe not so true. So I think that we're in our -- we just finished a 20-or-so year run of almost no inflation, and we're entering into an economic zone that none of us in our career have seen before. Last time interest rates have been anywhere even close to something like this, it was back in -- when I was 10. So I wasn't watching CNN at that time so I don't know what that was like. I just remember the gas lines in the back of my mom's car.

So I think it's a bit unpredictable as to how this cycle will end. Will there be a soft landing? It's going to be different. By the way, when people ask the question around the economy, I think they oversimplify because it's not one thing. If you're in the U.K., you're in a recession. You're in Western Europe, maybe, maybe not. In the U.S., not yet. So I think you're going to see different growth trajectories in different parts of the world. And that's a little bit of the beauty of Honeywell is we've got a broad portfolio with broad exposure so we will power through that all in. So yes.

Julian Mitchell

And when you look at the company, the connected enterprise is one element that's been important for a number of years. Kind of where do we stand on that? And then you talked about some of the business models, of the 4 main ones at the company, how is that software or recurring push the SaaS element coming along?

Greg Lewis

Yes, yes. So I'm happy with where we are. Que was the incubator of that in 2018, and she's taken a great opportunity to go to Medtronic last year. Now we've got Kevin Dayhoff running that business. And it's a little bit of like a VC mentality, we're going from one owner to the next owner. And Kevin is really bringing a lot of rigor around new product launch introductions.

For any of you who joined us in November at the Honeywell Connect event, we announced 15 new product launches during that event. And that's really Kevin's focus, is Que kind of built the foundation, now we've got to get these new products out into the market and he's doing that.

And so we're growing our recurring business over 20%. We are growing the SaaS business, and that's really what he's after, is to convert what he had into more cloud-based recurring SaaS offerings as well as embed new ones on the Honeywell Forge platform.

So -- and that business has been growing around about 15% plus or minus for the last 4 years. So it's $1.3 billion. So inside of a big $35 billion Honeywell, it's, I guess, you could call that relatively small. But a path to $2 billion is not out of sight at all. And by the way, a $2 billion software business in a space like ours is actually quite large and if you think about it in the multi-industrial context.

So it still is an important part of our overall transformation journey. Part of that is what underpins our confidence in margin rate expansion. If you've got a software business at above line average margins growing at 3x the rate of the overall business, good things will happen from a money rate standpoint. So it's one of the arrows in our quiver that keeps us confident that we've got a long way to go on our path towards continuing to improve our margin rate overall. So it's good progress. It's not exactly where we want it just yet, but it's good progress.

Julian Mitchell

Perfect. And then if we think about ESG for a second. If you think specifically about Honeywell, there's a lot of interesting areas around emissions reduction, technology, energy transition sort of underway within PMT certainly as a segment. Maybe explain how satisfied you are with Honeywell's progress in that transition.

Greg Lewis

Yes. I guess I would call it excited. I don't know whether I'm satisfied or unsatisfied but I'm excited about the opportunity because the more even I learn about it, the more clear it becomes to me that what we can do, not too many others can, and it's going to be instrumental for any company.

When I went to the Honeywell Connect event, I got the opportunity to speak there. But after the event, I told Kevin, "Hey, next time you do this, have some CFOs come in the audience, too." Because I'm watching some of the things that we're offering, I mean, he's offering emissions monitoring solutions that anybody who's going to have to sign a set of disclosed statements around ESG numbers is going to want to make sure that, that thing is super tight, and there's going to be a use case for that, not to mention some of the solutions that he and the PMT team have to reduce greenhouse gas emissions.

And if you think about the SPS business, it's over $200 million, it's on a path to $700 million. Carbon capture, battery, electricity, storage. We're doing things -- we announced a partnership with Nexceris, actually that's in the SPS business around sensing for EV batteries because in the electric cars, the lithium-ion battery can be dangerous, can overheat. So we've got sensing technologies that we're partnering with people there. We announced our partnership with Johnson Matthey in December. They've got some hydrogen technology. They're using our carbon capture technology along with it.

So I think you're going to see a lot more momentum towards these solutions, and we have some tremendous technologies to bring to bear. You're probably going to see more partnerships. I think that will be -- no one company necessarily has the full suite of things that are needed. So you're probably see more partnerships along the way, which is not bad. But I'm excited about it. That's why we think that business can grow to $700 million over the next few years just because the need is so large and our solution is differentiated.

So -- and again, we're playing across that whole energy transition. One thing we can all agree on is it's going to happen, right? The transition is not going away. Importantly, it's an and, right? It's an all of the above. In the meantime, energy usage is going to increase and traditional energy sources are going to be needed, so there will be investment in traditional energy and the energy transition. And this isn't like a 1- or 3-year thing. We're talking about decades, right? So you've got to keep in mind that it's not like the core of Honeywell's businesses is -- doesn't have a long runway, it does. And we're going to be adding this along to it.

Julian Mitchell

Perfect. And then capital deployment, you touched on at the beginning, you always get that question on M&A and you and Darius spending more time on it now with the CLO role being resurrected last year. Also though, we've heard from Honeywell at times, big software M&A is tough because it doesn't move the needle so much for the scale of the company. There's sort of an administration with tougher antitrust and regulatory backdrop. So sort of when you put all that together, what should people expect on M&A?

Greg Lewis

Yes. Well, M&A is always hard. I mean that's -- unless you're willing to pay anything, right? If you're willing to pay anything, you can do all the deals you want. And you know that's not us, right? We're not going to lose our discipline just because we feel we need to deploy capital or others want us to. So no, our discipline will remain intact no matter what it is that we're doing because it's our shareholders' money that we are working with, and that -- we never forget that.

So I guess that's one. I mean we absolutely want to deploy more capital. One of the things that I learned, and I've highlighted this in a couple of different forums with our sort of Act 1, Act 2 characterization of the last 6 years of our transformation, which really has been the great integration of Honeywell. One of the unintended consequences of that is it took up a lot of leadership bandwidth, my own, our business leaders, et cetera.

And now we've kind of gotten to the top of that mountain and we're on the other side coming down. It doesn't mean we're done with transformation, but it's just a bit -- it's not going to be as intrusive as it would have been to so much of the organization, which our expectation is it's going to free up capacity for even the business leaders to go do the things that need to get done because they have to go learn the markets, make the relationships. We're not the hostile takeover guys. So we want to make sure that we're getting to know the people and the businesses that we would like to bring under the Honeywell banner.

And then as you mentioned with Vimal becoming the CEO of the company, Darius now has more time to spend on other things. He said M&A, talent, strategy, like you've heard his 3 things, and he's doing that. I can guarantee he's doing that. So our pipeline is active. It's -- what we'd like to do, I'd love to be able to do 2 or 3 reasonably sized deals every year, $1 billion to $5 billion range, if you will.

Software deals are great. I mean the Sparta deal that we did, $100 million business, $1.3 billion-ish in terms of the check that we wrote. If we can find more things like that, I'll do that all day along. That's been a great business. It grew 45% this year. So it's -- we like software, but it's got to be the right company.

And you know this as well as anybody else. I mean M&A is -- you've got to take a lot of the bats. Do you close 5% of deals that you start with? Is it 7? Is it 10? It's not more than that. So the key is you got to really work at it and make sure you have a pipeline that's consistently evolving that you're taking swings at things.

And it is getting harder. I mean there's no doubt about it. The regulatory environment is more difficult than it was 2 years ago or 5 years ago. But that's true for everyone. I do think that it's a bit of a Honeywell advantage environment now for just with the capital markets where they are. So money is not free anymore, right? So that makes it a little bit more difficult for some other players. So hopefully, that will help.

So we'll see. I mean our hope and expectation is that we'll be able to deploy some capital into M&A this year, but we're not going to do it just to say we did it. So...

Julian Mitchell

Yes. Perfect. And maybe diving into some of the segments and the trends they're in, start off with Aerospace, the biggest one. Defense& Space has -- for a business that's sort of long cycle, it's kind of gone in waves, which is...

Greg Lewis

Yes. We had 3 years of 10%, 10% and 8% growth, and then the last 2 years have been negative.

Julian Mitchell

Right. So how are you thinking about sort of that bottoming process and then recovery path? And on the commercial side of the house, there are the questions around mix headwinds from OE rearing back up?

Greg Lewis

Yes. Well, maybe let me hit that one first because I've gotten a lot of play -- I mean, this is one of those things we're trying to be transparent and share some information so people aren't surprised later, and it seems to have taken on a bit of a life of its own. But just to be super clear, there is a dislocation with the grounding of the 737 MAX. And so therefore, almost no deliveries were going out. Production is happening. Our business model accounts for things called selection credits to the airlines when planes get delivered. And we've just had a dislocation in the delivery versus production.

That's going to go through a 2-year period. I think it's going to take '23 and '24, where deliveries are going to ramp. You guys can read that news in Boeing in their announcements. It's mainly with this that we're talking about. And that is going -- it's not -- it doesn't change the economics and the fullness of time of the delivery of an airplane for us, but it has kind of separated the recognition of cost of revenue over a longer time horizon.

So we'll go through this in '23 and '24, then that pinch will come back down in '25. And everything will be back to balance at that point, and we'll stop talking about it.

And I think the important thing to know, though, is we're -- the business is running at 27 points of margin. Our long-term target is 29%. And we still have every level of confidence that we're on a nice path to that long-term margin target. We're going to continue to get some nice volume leverage.

Again, as I mentioned, I think this business, broadly speaking, is on a very high probability growth curve. Part of that's because of the labor constraints in the supply chain that aren't allowing the supply to meet the demand that's out there. So it's going to take a couple of years, I think, for that to solidify.

So we're very confident in that business and our ability to grow it, to grow its margins and to make space for R&D as well, right? Because as you said, it's a long-cycle business. You've always got to be working on development programs for the future, and we're going to continue to do that.

Julian Mitchell

Perfect. And then if you would look at Defense& Space, kind of is that bottoming and growing?

Greg Lewis

Yes. I mean this kind of goes back to the past due backlog situation, right? We were down 3% in the fourth quarter if we were -- like if we just could magically release the past due backlog, we would have grown. So it's -- we're past the point of, hey, demand is down and we're now just at trying to catch up to being able to output enough to get -- to print the growth number. I expect we'll do that in Q1. And again, from there, just like the rest of Aerospace, it's going to be modest progression quarter-to-quarter-to-quarter.

We had a lot of discussion about the supply chain yesterday. It is getting better. it's not getting better enough for anyone in the industry to be happy. Everyone wants more, we want more, too. But like our output year-over-year in the fourth quarter went up 15%. That's good. It sequentially from Q3 to Q4, it went up.

Our suppliers de-commit rate has gone from around about 22% to around about 19% on larger volumes. So they're committing more stuff and decommitting less as a percentage. So things are getting better, but it's not like a semiconductor industry where you put some capacity in the ground and it's magically done the day after that. This is going to be a bit of a slower ramp than anyone would like. If we're surprised to the upside and somehow that goes faster, great. But we're going to plan for a modest improvement as we go. So...

Julian Mitchell

Yes. Great. And then if we look at HBT and SPS, those 2 divisions where you've had the orders under a bit more pressure than the other 2 divisions, sales-wise, it looks like you're assuming HBT kind of slows down later in the year. SPS maybe the declines narrow, so sort of divergent trends. Maybe help us understand sort of the outlook.

Greg Lewis

Yes, no, I think you have it about right. I think if you take SPS, we've talked about warehouse automation and the Intelligrated story for quite some time now. I mean that business grew from $800 million to $2.5 billion since we bought it and with a 50% growth rate in the middle of the pandemic, unfortunately.

And so we're -- that has come down fairly substantially, particularly on the project side. By the way, just keep in mind, the whole point of the Intelligrated model is to capture and build the service business and the software business. That thing is now about $400 million growing at 20-plus percent.

So in terms of the economic thesis as to why we like this business and the market that it's in and the capturing of installed base to create value with a recurring service and software business, it's working. And you're seeing that, by the way, in the margin improvement, in SPS, a big chunk of that is due to the mix change and the growth in the software business and the service business. So that's really good.

On the other side, in the products business inside of SPS, the sensing business is doing fantastic and continues to do so. It's about $2 billion of the portfolio. Sara Martin runs that. She's doing a great job. And again, sensing is relevant everywhere when you think about anything connected, when you think about sensing for things like sustainability measurements and so on, I love that business, and she's doing a great job with it, and she's got a lot of both organic and inorganic ideas to help make that thing better.

PSS, they had a huge volume increase in the back end of '21 and the early part of '22. They were one of the most constrained from a chips perspective. And so they're now working that backlog down, and we're hoping for a reacceleration of orders in the later part of the year, but that's one of the wait-and-see things. Yes, we'll see how that goes.

So -- and then the PP&E business, that's where we have the masks, and we know that whole story. Ramped it way up, ramped it way back down. And hopefully, that will start ticking back upwards with a little bit more solid economic growth overall.

So -- and then HBT, had some similar aspects to it in terms of pretty substantial orders and revenue growth outsized in the back half of '21, the early part of '22. They've got a very nice backlog to work themselves off of, but part of it depends on how does the economy go in Europe, in the U.S.

The good news is, though, again, back to the sustainability aspects, there's a lot of sustainability things there, too. And a lot of incentive programs in place that, while they may not matriculate in like immediately this quarter, those things are going to work their way into the business over time. And so we feel very good about that business overall.

By the way, that -- buildings is the biggest part of ACE, if you think about the connecteds. Connected buildings part is the biggest part of that. And that business overall, I think, is going to have, as it relates to the total, probably the biggest software opportunity of the 4 in relation to its total.

That's -- so I'm really excited about what Doug and that team are doing. And I love the business. It's turned into a bit of a star for us. It was our fastest grower last year. It's almost -- it's long-term margin target now. Still, we've got upside in front of us. But I think we've surprised ourselves to the upside with what they've been able to do from a margin perspective.

So yes, I mean, back to the beginning. That's why I feel great about where we are from a portfolio standpoint. We'll see what the economy throws at us. I guess what you should be as confident that you know that we know how to outexecute in any situation. When it was the pandemic, we were the cost management gurus. When it was hyperinflation, we were the price costs experts, and we'll see what happens with this next phase. But you know that we're going to run at the problems as they make themselves known.

One of the things you always hear in Honeywell is problems don't get better with age. So we're going to tackle them head on. So -- and you take that outstanding execution and then we add on some capital deployment, it should be a really attractive and compelling growth algorithm.

Julian Mitchell

Fantastic. Well, now, please, if we could switch quickly to the audience response. I promise it's very quick and painless. I think there's half a dozen questions. Well, in the interest of time, we'll just run through these quickly and then I'll collect them at the end of the day. But if you currently own this stock, if you could just push that gray box, the buttons on it. It's obviously all anonymous. So this is the first question. You currently own the stock, and you can see 1, 2, 3, 4 there.

[Voting]

Greg Lewis

Do I get the answers to this afterwards?

Julian Mitchell

Yes, sure, yes. We will send it around.

Greg Lewis

All the 4s can come and talk to the outside.

Julian Mitchell

Well, there's a lot. Okay. Next question, please. What is your general bias towards the stock today? Positive, negative or neutral? And you can see you've got sort of 5 seconds per question to hit the button. And then you'll see the results fairly quickly.

[Voting]

Julian Mitchell

So 1/3 positive.

The next question is around what will the sort of through cycle or medium-term EPS CAGR for Honeywell be and the peer set. Depends on the individual but versus sort of broad industrials or multi-industry, whichever.

[Voting]

Julian Mitchell

Okay. So basically, in line with peers.

The next question. What should Honeywell do with excess cash? There's obviously a lot of different options there and I understood that most companies do a mix of all 6.

[Voting]

Julian Mitchell

So people seem very happy with more M&A, which I think is consistent with what you've been saying.

The next question would be on what multiple -- and this one is maybe showing its age a little bit, the question. But for the sake of consistency, we don't want to move the ranges around year-to-year.

Greg Lewis

The answer today is 6.

Julian Mitchell

Right. Yes. So this -- yes.

Greg Lewis

We haven't seen 1, 2, 3 or 4 in a very long time.

[Voting]

Julian Mitchell

For quite a long time, yes. So most people think sort of 20 times.

And then I think maybe the penultimate question now, what you see is the most significant kind of headwind for the stock right now? The reason maybe people don't own it, the reason people are not positively biased towards it, that's the spirit of the question.

[Voting]

Julian Mitchell

And the answer is core growth, which I think goes back to that volume point.

And then this may be the last question on ESG. Last but not least, play -- does it play an active role in your decision-making relating to Honeywell specifically? And again, there is option 3, where you could say no, it has no impact at all, which is the most common.

[Voting]

Julian Mitchell

So I think that's it. We're out of time. Thank you, Greg, for a very illuminating discussion.

Greg Lewis

All right. Great. You bet. Good to see you.

Julian Mitchell

Thank you so much.