Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

In the art of relationships, it's important to manage expectations. That's a lesson Honeywell is learning all too well this week.

Late Thursday, the $81 billion maker of airplane autopilot controls and fire detection systems lowered its earnings and organic revenue expectations for both the third quarter and all of 2016. Honeywell now expects earnings this year to amount to $6.64 a share at most, down from a previous forecast of as much as $6.70. That in itself wasn't great, but it was made worse by the fact that Honeywell had affirmed its previous guidance less than a month ago at a conference hosted by Morgan Stanley.

Honeywell typically doesn't do abrupt about-faces. Under CEO Dave Cote, the company has built a reputation of being an Old Reliable in the industrial sector. When it gave guidance, shareholders could usually rest assured that the company wouldn't only to stick to the numbers, but in many cases turn around and beat them. You can count on one hand the number of times Honeywell's quarterly earnings have fallen short of analysts' expectations over the last decade, and even then the misses were by less than 1 percent. What happened?

Old Reliable
Honeywell has consistently beat analysts' earnings expectations.
Source: Bloomberg

As an explanation for the guidance adjustment, Honeywell pointed to portfolio changes such as the spinoff of its resins and chemicals business and the sale of its aerospace government-services unit, both of which closed recently but had been announced earlier. It also blamed worse-than-expected results at its aerospace division amid weak demand for business jets, as well as accelerated incentives. That's fine, things are tough right now, but it's not clear why it got so much worse -- and why the company wasn't better prepared for that. It's not like the problems in aerospace were unknown. Honeywell telegraphed these very issues in the second quarter as well.

Making such a surprising guidance cut is just the latest shock to the system for Honeywell investors who have already been caught off guard by the previously takeover-averse Cote's attempt to buy United Technologies for more than $100 billion. And needless to say, they weren't happy about it: They sent Honeywell shares down as much as 9 percent Friday.

We're Not Used to This
Honeywell plunged after surprising investors with a cut to its third-quarter and full-year guidance.
Source: Bloomberg
Intraday times are displayed in ET.

Is that an overreaction? Maybe. The underlying numbers in Honeywell's updated outlook aren't disastrous and the fact that it had to reduce guidance is certainly not all that unique as industrial companies grapple with an ongoing slump in commodity prices and global growth. Honeywell is still on track to increase profits for the seventh year in a row, an enviable track record by almost any measure. And while it now expects organic sales to decline as much as 2 percent in 2016, the company has plenty of balance sheet firepower to buy revenue expansion through M&A. As JPMorgan analyst Steve Tusa put it, ``it's not that bad in the grand scheme."

But this is Honeywell we're talking about. In addition to expectations for reliability and transparency, investors have grown accustomed to it doing a lot better than "not that bad." Honeywell has proven time and again that it's a skilled operator capable of pushing profits higher even during downturns. The problem is, margin expansion will get more difficult after years of aggressive slashing and the growth just isn't there to pick up the slack. Honeywell is targeting segment operating margins of 17.9 percent to 18.2 percent this year, versus a July forecast for 18.9 percent to 19.3 percent.

Playing Catchup
Honeywell's valuation lags behind some of its U.S. and European peers, despite the advancements it's made in terms of improving profitability.
Source: Bloomberg

Honeywell is still a great company and it's in a better position than a lot of other industrials. But with Cote getting ready to hand the reins over to Chief Operating Officer Darius Adamczyk, the company needs to reassure investors that it can still be Old Reliable.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. This is based on the average of analysts' estimates compiled by Bloomberg.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net