Honeywell Value Gap Spurs CEO Chasing Darling Status Lost by GE

Honeywell International’s Chief Executive Officer Dave Cote
Honeywell International’s Chief Executive Officer Dave Cote. Photographer: Andrew Harrer/Bloomberg

Dave Cote has won analysts’ support for his view that Honeywell International Inc. is on a path to higher margins and revenue growth that merit a premium stock valuation. Converting investors may prove tougher.

Honeywell’s chief executive officer may tell investors in New York tomorrow that the maker of cockpit electronics and work boots is set to meet a 2014 target of boosting a benchmark gauge of profit margins to as much as 18 percent, up 470 basis points from 2009, said Deane Dray, a Citigroup Inc. analyst.

Cote’s goal starting his second decade as CEO is to join manufacturers such as Danaher Corp. and Emerson Electric Co. with price-earnings ratios topping peers’. His challenge: Even with a six-month, 30 percent stock surge before today, Honeywell’s 13.6 ratio still trails the 14.7 average of the 61 companies in the Standard & Poor’s 500 Industrials Index.

“I’m not convinced yet,” said Gary Flam, who helps manage $6.5 billion for Bel Air Investment Advisors LLC in Los Angeles. “I’d like to see how they perform through a downturn to have the confidence that it’s truly a repositioned business and not just benefiting from an upturn.”

Flam still wasn’t ready to buy after a Feb. 23 conference in Miami where Chief Financial Officer David Anderson previewed tomorrow’s planned remarks from Cote. CEOs want their stock to be seen as a must-have when prices rise and a buying opportunity when they fall, a status that can take years to earn, Flam said.

Danaher, Emerson

While Morris Township, New Jersey-based Honeywell has buy ratings from 15 analysts to seven holds and no sells, its price-earnings ratio lagged behind yesterday’s 18.8 for Danaher, which makes microscopes and water-treatment systems. Emerson, a maker of motors for assembly lines and compressors for air conditioners, had a ratio of 15.7.

Honeywell’s ratio also was lower than the 14.1 for General Electric Co., “the darling stock that everybody loved” before losing that halo as U.S. stocks slumped in late 2008 and early 2009, said Scott Davis, a Barclays Plc analyst in New York.

GE’s ratio averaged 34 in 2001 -- the year it dropped a bid for Honeywell -- and peaked at an average of 48 in 2000. At $46 billion yesterday, Honeywell’s market value trailed GE’s $199 billion and exceeded the $36 billion each for Danaher and Emerson.

Five years ago, analysts struggled to gauge Honeywell’s progress because earnings were marred by charges and impairments, such as costs for asbestos settlements, said Citigroup’s Dray in New York. Businesses that underperformed or didn’t fit have been sold, Dray said. The Consumer Products Group was sold in July in a cash transaction valued at $950 million.

Meeting Targets

Now, Anderson said Honeywell’s ability to command a higher PE will pivot on meeting 2012 and 2013 profit targets. Earnings will get a bump from $150 million of cost savings starting this year, Honeywell has said.

“We’re demonstrating top-tier performance,” Anderson said in an interview. “To get to a premium valuation, and that is where you want to be, you need a little more proof, demonstrating through this time period that we can perform. If we do that, we have a good shot of that happening.”

Honeywell closed yesterday at $59.10 in New York, up 4.6 percent in the past year to outstrip a drop of 0.5 percent for the S&P 500 Industrials and a 3.3 percent gain for the broader S&P 500 Index. GE fell 7.5 percent in the same period.

Merger Collapse

Cote, 59, took over in February 2002 as Honeywell reeled from the collapse of the GE merger agreement four months earlier, after European regulators vetoed the deal and then-CEO Michael Bonsignore was ousted. Honeywell was losing market share and employees were jumping ship, said Steven Winoker, a Sanford C. Bernstein & Co. analyst in New York.

“They were continuously disappointing and highly undermanaged,” said Winoker, who recommends holding the shares. “That’s changed.”

Cote, who previously ran GE’s appliance business and was CEO of TRW Inc. in 2001, cut operating costs, boosted spending on new products and worked to meld separate cultures that persisted after Honeywell’s 1999 acquisition by AlliedSignal Corp., which kept the Honeywell name.

“He has done a good job restructuring the company,” said Diane Jaffee, a New York-based fund manager for Trust Company of the West, which owns Honeywell shares. “It was basically gutted after that failed takeover by GE.”

Benchmark Margin

Honeywell’s benchmark margin is based on profits from its four main segments, which excludes corporate expenses, divided by the units’ sales. The company’s five-year goal is segment margins of 16 percent to 18 percent by 2014 and sales of $41 billion to $45 billion, as much as 23 percent more than in 2011.

The so-called segment margins have risen an average of 0.5 percentage point a year since 2003, according to Anderson’s presentation at the Feb. 23 conference.

Businesses driving earnings include digital cockpit controls and auxiliary power units for aircraft; a performance materials unit that serves the oil and gas industry; and a safety unit specializing in personal workplace protection, said Dray, the Citigroup analyst. He rates the shares as “buy.”

The company should be on its way to being an investor darling, said Dray, who bestows that status after studying indicators such as return on equity, organic sales growth, non-U.S. revenue, free cash flow, and earnings through peaks and troughs.

Litmus Test

“One of the clearest, unbiased litmus tests is when you start seeing these companies trading at a premium consistently, not just for a quarter,” Dray said in an interview. “This momentum toward excellence and the marching up of the margins is sustainable, and Honeywell can get there.”

Bel Air Investment Advisors’ Flam said he likes Honeywell’s markets and agrees that management has improved operations. He also noted difficulties ranging from Europe’s economic slump, which is damping sales of automobile turbochargers, and cuts in U.S. military spending weighing on the aerospace unit.

An underfunded pension plan will force contributions of as much as $1 billion in 2012, asbestos claims are forecast this year to be $165 million net of insurance recoveries, and costs for environmental remediation are estimated at $300 million, according to a Honeywell filing on Feb. 17.

“Expectations from investors are starting to rise,” Flam said. “If the company continues to execute, I would expect the multiple to continue to expand. You have to earn your stripes.”

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