Honeywell International Inc. (HON) Earnings Call Transcript & Summary

Good morning, everyone. This is Nicole DeBlase, Deutsche Bank's multi-industry and electrical equipment analyst. We're back with Honeywell, pleased to introduce Mike Stepniak, CFO; and we also have Mark Macaluso in the room, SVP of Investor Relations. So please keep this interactive. If anyone has questions, please feel free to jump in. I'll stop my questioning a few times throughout to just make sure everyone is getting their questions in.

But Mike, I thought I'd start with some high-level stuff for you. So now that the 3-year portfolio was complete, how does management define success for Honeywell Technologies as a pure-play automation company? And what tricks will you hold yourselves accountable to the next 12 to 24 months?

Sure. So first, thank you for having us here today. Super excited to be here and years are progressing extremely well, strong [indiscernible] orders in July are looking good. That's why we raised the guidance and feel good about the second half. As far as your question and -- we just laid out -- this is our first month file as a new company. We laid out our 3-year growth targets, so 4% to 6% top line growth, double of [indiscernible] in 2029 and strong margin expansion as well as a 90% class free capital conversion. We're off to a good start. We feel really good about the second half. And based on how the orders are coming to make sure it looks quite strong as well.

That's great to hear. And I guess maybe just double-clicking a bit on what you guys are seeing from an orders perspective. Can you talk a little bit about like short cycle versus long cycle trends, maybe things that are standing out in different parts of the portfolio is particularly strong?

So as you know, we put a lot more emphasis on higher growth verticals within our portfolio as far as [indiscernible] how we focus commercially. We reorganized a lot of R&D within industrial commission, process automation and building up mission as far as being customers in. We see broad-based growth across all of our [indiscernible]. So historically, the last few years, Europe was a headwind for us. That's no longer the case. China is doing okay. It's obviously pressure, but we use this surprisingly as strong for us. Other parts of Asia, North America is really strong. So that's what progressing well. And that's where really the short cycle is. We're seeing growth in our traditional verticals, but obviously outside in the fiberoptic. That's progressing well. And on top of that, we have a long-cycle demand. So we talked all about our process business, getting a lot of orders and building backlog. That backlog is starting to convert. On top of that, we have incremental [indiscernible]. So the conflict in ground stimulate demand in Middle East as far as rebuild, but also Middle East as far as just security and then a lot of what has been in the book [indiscernible] for reclassing the new world order, if you will, and how they're going through what managing our supply chain. So things really, I would say, generally very good backup for us going to the second half of this year.

Okay. And we'll definitely get into each of those areas as we talk through the segments. But maybe sticking with some more of the high-level questions. As you become a more nimble pure-play company, what should investors expect to remain the same versus the Honeywell we've known for many, many years? And what might be different?

I think what you -- what we are noticing is that we are much more focused, much more focused and our core, very into methodical in terms of how we execute. What's maybe where we are pivoting and where what is different is much more on commercial [indiscernible]. So core innovation with our customers about our focus on innovation. We'll be doing some M&A, we'll continue to do M&A and our team is committed to continue to do M&A to supplement our portfolio. And then at the core, it's really, I would say, for us, it's accelerating -- accelerators within our backlog as far as how we run the portions, we leverage accelerated to expect margins, and we'll continue to do that. Last few years, accelerator program focused on us in terms of our revenue models and driving positivity across the company as far as how we deploy our revenue models. Last new years now, we [indiscernible] towards Six Sigma supply chain excellence. And then now we're pivoting in game into artificial intelligence and probably leverage accelerator there. So it's ever evolving, but the management of earning systems that we had our other of everything we're doing.

Okay. Okay. Understood. So software and services, I think at your Investor Day, you targeted 45% of revenue to be generated from software and services over time. Where does that stand today? And what's like the big pieces of the road map to get you to the 45%?

It's really important. And important offering. So last year, we connected more assets last year of the 5 years prior. So if you think about the investment we've done in Forge over the last 5 years is starting to pay back in a very meaningful way. Over the next 2 to 5 years, we'll [indiscernible]. Today, we're about, I think, 5 million of sets were connected, which will to be connect about in total, 9 million assets. So why is it important? The connection really gives you a gateway that we will try to innovate with customers and provide solutions, et cetera, the [indiscernible] those connections. So really excited about that, and that's where that 15% annual revenue growth comes on software space.

How does AI fit into Forge? Like are you enabling -- are you using -- are you applying AI tools to Forge that some that becomes available for customers?

That's correct. So we're building [indiscernible] competition of the assets as far as learning abilities at these AI models.

And how is the customer response to that been so far?

Very good. I think generally, if you think about where we were 5 years ago, there's a lot of hesitation as far as getting access to data sharing data, et cetera, not people realize it's really necessary. And I think the cybersecurity got much better over the last 5 years as far as being able to contain phase affect your data and your main knowledge. And that's going to swing out quite well.

Okay. Okay. Understood. And how is -- I mean you've got 2 specific AI factors here. You've got the tools that you can use for Forge to drive adoption. And then I would assume that you're doing a lot with AI internally as well. Can you talk a little bit about that?

Yes. It's actually quite a significant topic for us as a company. We just made a big investment in real as far as equipping all of our associates with -- with AI tools and pilots, et cetera. And now we're building all that up. Look, there's common knowledge I think would tell you that a person that proficient in AI, would probably saves 2, 3 hours that we give in their productivity. That's great, but for us is much bigger than that. And we're really focusing on being able to deploy AI at scale. I can give you a couple of examples. Within our engineering organization, we're using AI for drawing between those splitting proposals and set up that's tens of thousands of hours of productivity that our engineering team can do and can get to market faster with proposals. A final function a couple [indiscernible] we do now balance sheet analysis using AI. So we gather our balance sheet, the growth in our free funded [indiscernible] and AI tools analyzed that for essentially variances for comments that analysts would do help you look at phase, help you online much, much more be [indiscernible]. Same with audit. We will leverage a lot of AI doing our internal audit. Part how we would do the [indiscernible], how we think about various solid cycles. So there's a ton of productivity out there. You just have to be very, very purposeful and I would say [indiscernible] we need to make sure you can go in the right areas.

Okay. Okay. Understood. After the Investor Day, I would say there's still kind of a good base of investors that are skeptical, I got the 4% to 6% long-term organic growth target can be met. What would you say to those skeptics?

I guess I would say we're going to prove it. I'm a big data. And -- if you step back and when you look at the business and why I feel so confident we will achieve those targets, it's looking at leading [indiscernible]. Our orders pipeline is extremely strong. We are being successful as far as focusing on verticals. We have done a very good job integrating our acquisitions, which is driving growth. We have been very diligent and purposeful in terms of how we deploy products. And we've been spending a lot of time on driving our NPI machine, which we'll talk about it. And it's hard to really show you the data kind of day-to-day, but we see sitting pipeline, seen in the orders [indiscernible] customer sentiment scores. And then finally, we've done a lot of work in terms of self-help in our industrial commission business as far as customer delivery being better time to deliver as far as first from as a customer 1 day, the [indiscernible]. So we have now 3 businesses all of which are gaining momentum and growing and both on the short cycle and [indiscernible]. So feel really good about the progress the team has made and where we're going forward.

And I guess it also helps that you did put a few points of contingency into that outlook?

Point of things, we don't [indiscernible], inflation or pricing, maybe not at 4%, et cetera. So it's there. So I feel the 4% to 6% framework is that's a good framing for us. And obviously, everybody's incentive bikes to be best.

Got it. You talked about NPI, and I thought this came up a lot at our dinner last night. I thought it was interesting. It seems like that's an area where at least from an outsider, it feels like you guys are kind of doubling down on NPI after the spin, and that's been something that feels like it's changed a little bit. Is that -- is MPI something you're excited about across like all of your businesses?

And obviously, each of our businesses are -- it's a little bit different stage of the journey. I would say the building automation business is [indiscernible] they've been working on the SDI machine for the longest. And what I mean by it is making sure that they are diligent on how much money to spend. I know that I, their provision, they're very thoughtful in terms of launching NPI timely, making sure the supply chain rate is ready to fulfill [indiscernible] working closely with customers and collaborating both with channel partners and great customers as far as what the launch went to launch and product features, et cetera. So that's what working extremely well. Industrial Automation has been on it now for about 18 months, and we start seeing successes, and they have all exciting launches coming out. And process automation technology, that business was just in the lower in the cycle for this one. So the API is a little bit slower there. But nonetheless, team had some really cool things coming out as far as process technologies. So yes, so I would say, generally, the NPI machine is firing on all.

And I would assume that with NPI, you probably have the opportunity to get some of that price that people perceive as aggressive in the guidance, and so maybe that kind of contributes...

NBI it tends to best come with better price of events however you think about it. Generally within first 2 years as accretively business, which is great. Where we're managing the overall demand has been [indiscernible] things, but as we ultimately look to grow EPS. So while we are so much price we drive demand [indiscernible]

Okay. Great. Then maybe just shortening the lens a little bit, to 2027, we're starting to get investors focused on 2027. It's a big part of the conversation now. Strikes me that Honeywell could have really nice above average, maybe even top tier earnings growth in 2027. You've got stranded costs coming down, you've got interest expense coming down. And then on top of that, we have clear acceleration in order trends. Do you agree?

I do agree. So in the second half, we'll grow 4% to 6% hoping more closer to 6% versus 4%, as our first growth -- that gives you a really good -- I would say that up to 2027, especially the first time. So feel good about that as well. That bankers are in our favor, businesses are performing. As far as margin expansion, we talked about it at the Investor Day, we'll get much more margin expansion in the near term versus later term. So '28, '29, we should get to the more normal 60 bps margin. In the near term, this year, next year, will the market expansion is going to be much more [indiscernible] we're still working to tailwind from the portfolio transformation, trend the cost takeout set up. As far as the EPS drop exchange, 15% is growth. I think that gets us to that $12 in 2029. But that's something that we're instrumenting the teams.

Okay. Okay. Perfect. So I wanted to start drilling down into the segments. So starting with Building Automation. I think the biggest question I get from investors is like how is it growing single digits. Can you give us a window into what's going on in that business to drive such strong growth and maybe the sustainability of that?

Sure. So it's not the one thing. That's the great thing about Building Automation. This is Building Automation is a business that's the most diversifying as far as the end markets as far as the big diversified regionally. And how the revenue comes together. So it's a multitude of things, not 1 thing. If you just look at data center, data center is about 5% of Building Automation. Yes, it's growing tremendously, but it's only 5% of the overall business. So your question is how sustainable is it? I think it's fair to say that this business has a good runway to be able to grow at mid-single-digit glass for the foreseeable future. We're not guiding in high single digit, just to give the team a little bit of room, if you will, to experiment, to do things that they need to be able to grow and to really manage for the longer term versus just the short term and the 90-day. From a margin expansion standpoint, that's really where I'm excited about. The business will finish this year about 27%. But we have a really good lifecycle business to be 29% margin in 2029. And I don't think that -- sorry -- so really just going to [indiscernible] and once again, on innovation, customer propositions, software, Forge, et cetera, all the team. The business is getting really good leverage right now. They're investing in R&D. There's a lot of good things going forward.

Okay. Understood. But I guess, just to be clear, like -- is there anything happening now within that high single-digit growth rate that shouldn't be viewed as sustainable, certain end markets that you think won't grow as fast in the future or maybe a surge in NPI that could slow down? .

I would say there's -- no red fastly. But like I said, the business is well diversified. So it happens in Europe for. And all of a sudden, there is a demand structure is [indiscernible] so then check that might have a change then in the impact from the business as 7% to 8% in 6 months right? So that's why we're guiding the business that we guided.

Okay. Fair. And then data centers, you mentioned about 5% of sales today. That was 0 not that long ago, right?

Yes. They're about 3 years ago, it was a -- we would like our data center business to [indiscernible] over the next few years. So we would like to be over $1 billion. And it should be 10% of the building and mission business. We'd like to help Building Automation business to be [indiscernible] for our business.

And what are the key -- remind us what the key products are that you're self-selling into data centers today? I get that question a lot.

Look, it's really a lot around fire sensing, security, physical superior monitoring building management systems, those types of things. And then as you -- as the data centers become more sophisticated, there's also a lot of pre-sell-off other parts of the business. So think about all new data centers will require them on power studies. We have a lot of [indiscernible] so managing, sensing the low, the stability, liquid cooling with the data centers with these higher compute [indiscernible]. They require a different [indiscernible] we have a lot of great that we're launching on sensing quality leasing that up. So there's just a big opportunity for sure.

Okay. Okay. Perfect. And if you were to kind of look at the order and the revenue growth recently within BA, which regions stand out? Or has the strength truly been global?

The stream is global. I mean, China sees a little bit...

Construction is terrible there...

Yes. It's just slower growth, right now, but we're still doing okay. But Europe is doing extremely well. North America is doing extremely well. Middle East, other parts of Asia, outside of China as well. So it's broad-based.

So kind of outside of China everywhere else is doing pretty. Okay. That's great. And you mentioned your excitement about margins improving, which kind of surprised me because the margins have been expanding so much for so long. Like what do you view as the key levers to unlock getting to 29% and then going further than that at some point?

It's really NPI, Forge and Boeing leverage. So those are the things. We talk about it, but they're just a minute of NPI is accretive. You have good NIPI, took delivery, you can demand a better pricing. And as long as your NPI demonstrate savings for your customers. So obviously, participating in the [indiscernible] savings. So we feel really good about it. And Forge, it's really, I would say, something very unique and margin for us, and we -- as we commercializing, we see a lot of [indiscernible]

Is BA where Forge is maybe the most evolved? Or is that the wrong assessment from an external perspective?

It's more of a [indiscernible] I would say -- we have the most penetration. After that, it's really in process automation.

Okay. Okay. Makes sense. Okay. I think that's pretty much everything I had on building automation unless anyone else wanted to add? Okay. Perfect. I'm going to move on to Process Automation and technology then. I guess, maybe if you could talk, Mike, about the impacts of what's happening in the Middle East to process automation. And it seems like you're already starting to see some of the positive effects of that conflict with respect to the oil price on orders. Can you talk a little bit about what you're seeing in real time?

Sure. So we just have a ton of demand across the board. And what the conflict, I would say, generated is obviously, it generated higher prices for -- within the oil and gas industries. And with that, there's we say in the -- if you look at the first quarter, there was maybe just a pause on catalysts as people were trying to run their facilities harder to get the benefit of the oil prices being higher. As people realize that oil prices are going to stay higher for longer, people are taking down their facilities and reloading, if you will, to run them efficiently for longer. So we're seeing an inflection in the catalyst demand. And our colors demand, if you look at the second half versus first half, it's going to be up double digits. It's still about flat for the year, but the second half year-over-year will be up high single digits. So we feel good from a short cycle demand. From a low cycle demand standpoint, what we are seeing is a much more pronounced build out outside of Middle East of new facilities. If you think about Africa, if you think about Asia, we see activity also in [ Latin America ]. So it's broad-based. And obviously, LNG is performing extremely well right now. For our LNG business, it's essentially -- I mean we're taking orders for slots in the end of 2028. So we're building our capacity in our LNG business to continue to support the demand. And then there's some rebuild happening in the Middle East as well, which is, I would say, it's outsized growth. It's obviously just 1 point in time bubble that we have to accommodate with our customers. The bigger of being both in Middle East is, people are focusing on resiliency. So we see much more demand out with from our gross automation business, especially around cyber, building automation security set up, and that's also helping with this.

Okay. And I guess if you were to kind of bifurcate what you're seeing in orders for process technologies versus process automation, are you seeing a pickup kind of across the board?

We see a much more pronounced pickup in process technologies. And process automation, at least our experience has been the process automation is about 18 to 24 months defined on technologies. So when Process Technologies was going down in 2 years ago, 18 months ago, versus automation was still growing for us. Now process technology is starting to grow, trusted automation is kind of flattish. It's going to grow faster next year. In Process Automation, too, there's an interesting dynamic that our Process Automation business is moving to new verticals as well. So if you think about life sciences, if you think about a little bit of discrete from pharma medical devices built out. If you think about cyber, if you think about U.S. onshoring and semiconductors business. All that is helping the business grow as well. So it's actually diversifying quite nicely.

The only thing I'd add to what Mike said is, last year, remember, we had a couple of mega being really big orders in starting the second half of last year. So the book-to-bill ratio still be strong. We're starting to bump up, especially in PD up against some really big comps, a couple of multi-hundred million dollar orders in 3Q and 4Q of last year. So still great demand, but just the variances are going to look a little different as we bump up against those tough comps.

That's exactly right. You'll see probably our orders in PT to be potentially down in the fourth quarter maybe in the third quarter. Book-to-bill is up way above 1, and the revenue inflection is happening. So it's just the nature of the cycle and obviously like Mark said, we're lapping some really, really big deals.