Promising Growth Prospects for Wide-Moat Honeywell

Joshua Aguilar: The market has historically denied Honeywell a premium multiple, like wide-moat rated 3M. Even so, we think Honeywell is a company that is equally as high-quality as 3M but one with more promising growth prospects. Our new thesis is underpinned by confidence in, first, the firm's culture of independent thinking, which contrasts with that of GE; second, a rigorous process modeled after the Toyota production system; and third, a portfolio with a massive installed base that's becoming increasingly integrated with software.

In terms of Honeywell's portfolio, we're keeping close track of a few business lines, which we think are ultimately going to move the stock going forward. First and foremost, we're most enthused by Honeywell's warehouse automation offerings, which were particularly strengthened by its acquisition of Intelligrated in 2016.

Intelligrated was a small private company developed by two very smart gentlemen out of Ohio in 2001. The acquisition brought Honeywell, among other things, a suite of products that includes robotics, palletizers to handle packaging and containers, and a software platform for e-commerce and omnichannel fulfillment. This complimented Honeywell's previously limited portfolio, which from our understanding, mostly consisted of handheld and voice recognition devices. Intelligrated, however, benefits from Honeywell's global scale and an increased magnitude of work orders. Honeywell, meanwhile, benefits from a business exposed to e-commerce trends that far exceeds growth in traditional retail, posting double-digit rates of growth in the most recent quarters.

Our expectation is that over the next five years, Honeywell can sustain a 9% compound annual growth rate in sales. According to some estimates, only about 5% of U.S. warehouses are automated, which gives us confidence in our expectations for growth.

From a moat standpoint, we're most impressed by the firm's Aerospace segment. This was a business that came under pressure from outside activists and tested CEO Darius Adamczyk early on in his tenure. We think he made the right decision by spinning off Garrett, the firm's automotive turbo engine business, which never really fit in the with rest of the Aerospace portfolio. That said, we think he rightfully held on to the rest of the Aerospace business, which we estimate posts returns on invested capital of over 30%, even when including goodwill.

Aerospace boasts the largest installed base in the industry, which includes 36,000 auxiliary power units, which are the small turbine engines used to conserve power as passengers board and are located near the back of the plane, as well as 20,000 flight management systems, among other products. The firm also gets an important uplift to its R&D budget in the form of contribution from the U.S. government, which really allows Honeywell to spend 7% of sales on R&D versus the 5% or so of sales Honeywell reports.

The stock has recently seen some price appreciation since we transferred coverage, but if it gets cheaper relative to our $168 fair value estimate, we wouldn't hesitate to recommend it for an investor's watchlist.