Honeywell International's Management Presents at Morgan Stanley Industrials & Autos Conference (Transcript)

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Honeywell International, Inc. (HON) Morgan Stanley Industrials & Autos Conference September 17, 2013 12:10 PM ET

Executives

Tom Szlosek - VP, Corporate Finance

Elena Doom - VP, Investor Relations

Analysts

Nigel Coe - Morgan Stanley

Nigel Coe - Morgan Stanley

Okay, great. So we’re going to get restarted with Honeywell. On stage we’ve got Tom Szlosek, VP of Finance and Elena Doom, Investor Relations and Elena congratulations on the big ring.

Elena Doom

Thanks, Nigel.

Nigel Coe - Morgan Stanley

So Thomas you have got a presentation, so take it away.

Tom Szlosek

Yes, great. Thanks. Nigel thanks for having Elena and I here. We are really happy to be representing Honeywell. Since I started in my role in early April, I had a chance to interact with a number of you. I look forward to hearing what’s on your mind today. So like Nigel said, I got a few prepared slides, I will quickly go through them. First the standard, we do have forward-looking statements in here. The actual results could materially differ. I encourage you to look at our risk base disclosures that are on our 10-K and other information on our website.

We’re coming off a strong first half, 14% EPS growth. That’s 9% when you adjust to normalize our tax rate to the full year 26.5% tax rate in a fairly, a flat type of growth environment, it shows 1% there reported, but actually organically flat. In terms of the outlook for the rest of the year, we are reaffirming our guidance for the third quarter and the second-half. That does include the impact of the Intermec acquisition that you may have seen closed this morning.

And in terms of our long-term targets, we continue to be on track with those who actually be able to hit the or expect to be able to hit the margin portion of the long-term targets a year early and I will show you little bit more on that in a minute.

In terms of our portfolio, Honeywell offers a diverse portfolio. Our businesses are in spaces that take advantage of trends around safety, security, energy efficiency, productivity of our customers, globalization of our customers. We are in over a hundred countries in the world. The non-U.S. piece of our business continues to grow. As you know we made some organizational changes over the last year and half to -- and put in a President in high growth regions to ensure we’re getting the resources and the investments in those areas.

Then from an SBG perspective as you know we’re in four businesses that give us good exposure both long cycle and short cycle. So how did those businesses perform? This is the first half numbers I think you’ve seen in these. I call your attention to the right hand column in particular. Yeah, we’d all love better markets and we think better days are ahead from a market perspective. But even with the flat sales growth, we’re able to improve segment profit by 5%.

We are able to drive the margins up 60 basis points. And with no sales growth, that really is a reflection of all the things that we continue to talk about, the Honeywell operating system, the Velocity Product Development, Functional Transformation, OEF, all of those initiatives result in opportunities for restructuring. And to the extent we have restructuring funding available and we fund it and we execute those projects you see the result, the margin rate improvement.

In addition, on net income and EPS even in better markets, we’d be pretty proud of 15%, 14% increases there. And then from a cash flow perspective, we continue to drive free cash flow in line with the earnings growth. A little bit of update on our portfolio, we’re seeing good strength in the Aerospace aftermarket both on ATR and BGA side. EOP continues to do well for us in that oil and gas space as well as HPS.

Europe has also been very good for us. And surprisingly our exposure there is on turbo and on the ACS short cycle businesses we’re getting nice traction there. China is improving significantly from the first half. So we're happy with what we’re seeing there as well. From a -- from the portfolio – from the stable part of the portfolio, we have the ACS -- well first of all that the Aerospace business is on the OE side are doing very well. Elena are we changing the slides? Okay.

I think we might have a slight glitch with the slides, but let me keep talking about the …

Nigel Coe - Morgan Stanley

Are these the internal slides?

Tom Szlosek

Yes, I think these are the internal slides, no but it’s fine. We …

Nigel Coe - Morgan Stanley

Right. You can go.

Tom Szlosek

(Indiscernible) a word with this. On the Aerospace, on the OE side, we’re seeing that mid single digit growth. So both again ATR and on BGA, the residential businesses and ACS across the rest of the world are doing well and then from a challenge perspective we continue to see challenges in Defense and Space. As you know the U.S government on Defense side is spending 7% to 8% less in terms of funding than they have in the past and we’re calling about 4% on declining revenue in our portfolio for the year. As well Advanced Materials we’re seeing a little bit of slowdown there as you’ve seen over the course of the year. But we’re seeing some signs of brightening; the comps get a little bit easier as we head into 2014.

In terms of the 2013 guidance, we’ve shared this with you before. No changes in the numbers as I’ve said. This does reflect the dilutive impact of the Intermec acquisition, which combined with the other acquisitions that we will do will be about 4% dilution during the year. So the guidance range still 485, 495 and for the third quarter still at 122 to 125.

Cash has been a nice story for us as well. As I said, we’re up 10% year-over-year. We continue to convert at a rate that’s a multiple of our net income growth. In terms of our portfolio -- in terms of our priorities on cash redeployment, obviously it's reinvesting in the business. We will do CapEx this year about 1.1 billion to 1.2 billion. We expect that rate to continue into 2014. Then we should get back to normalized levels at sub $1 billion in 2015.

Also from an M&A perspective, including that Intermec acquisition I talked about, this year we will do about $1 billion M&A and expect that to continue in 2014 kind of at that run rate. From a return to share owners’ perspective, we continue and Dave Cote continues to want to drive that dividend up in line with the earnings growth. Generally that has been a 10% increase over the last few years and we hope to continue with that pace. And we also are opportunistically we will look at the buyback opportunities and I think at a minimum keeping the share account flat is where we’re headed.

Talked about restructuring and I just want to drive this point home, because of the impact that it had – it has had so far on our portfolio this year. The 60 basis points margin rate improvement in the first half, we expect that rate to continue in the second half, which you saw on the previous slides.

We have a portfolio of unexecuted projects of $350 million. You can see how it cuts across each of the four businesses. And what that means for us is $90 million to $100 million worth of tailwind as we head into next year. So even in a slow growth environment and by the way we expect next year to be a little bit less slow than this year, but even so, we do have some good tailwind there.

And the other thing that I would say is that, I get this question a lot is, is this the end of the restructuring. For us -- for every dollar restructuring that we end up funding, approving and funding, we probably get 3 to 4 times that in terms of request from the businesses from restructuring. So I believe the pipeline of opportunities continues to be very robust.

Last is an update on our long-term outlook and our targets. You remember in 2009 we issued targets for both revenue and for segment profit. From a revenue perspective, we said that by 2014 we would increase revenue between $11 billion and $15 billion. At the end of 2013 we expect to be at 9 of that 11. So making good traction on that piece. The segment margin, we said that in year five we would grow it between 270 and 470 basis points. We will hit that -- we will actually hit that number a year early. So we should be at a minimum 270 basis points margin improvement in 2014. So that gives us opportunity to further penetrate that range in next year it comes around.

So that’s basically -- I just want to reiterate we’re happy with how we’ve done so far, 2014 or 2013 expected to continue we’re reaffirming the guidance. And in terms of the long-term targets as I said, I think we’re on track and we look to share our perspectives on the next set of five year targets with you at our Investor Day in the spring. So thank you Nigel.

Nigel Coe - Morgan Stanley

(Indiscernible). Okay. So how are you enjoying life at corporate?

Tom Szlosek

It’s pretty interesting as you know Nigel I was there for -- I was in ACS for six years as Roger’s CFO and before that I was in corporate for about two years, as a Corporate Controller. So I know my way around the building little bit, but in terms of the new areas of responsibility, Investor Relations, Treasury, Tax and the like its definitely a learning curve, but its something I really enjoy and its nice to be part of Dave and Dave’s team.

Nigel Coe - Morgan Stanley

Yes, it’s a big campus.

Tom Szlosek

Yes.

Nigel Coe - Morgan Stanley

Getting around?

Tom Szlosek

Yes. We are going to make it better. We will make it a better campus.

Nigel Coe - Morgan Stanley

So you talk about the end markets and strong, stable and weaker, just to clarify is that incrementally weaker or you just …?

Tom Szlosek

I look at it -- relative to our guidance on balance, none of the guidance changes. We kind of just want to give you a flavor of what we’re kind of seeing right now. I don’t think they’re materially different than what we contemplated overall, when we did the guidance.

Nigel Coe - Morgan Stanley

And you said next year is going to be -- you think its going to be less slow, I think it was the word you used. So what gives you confidence that next year is going to be less slow and which end markets do you think will be even more lesser?

Tom Szlosek

I think first of all if you look at the exit rates that we’re dealing with right now, I think the -- from where I come from the ACS portfolio, the short cycle businesses seem to be on a roll right now. Certainly the backlogs in our businesses are holding firm, I mean, we continually tout the UOP backlog, but the backlog in HPS and the other longer cycle businesses in Aero -- equally are holding firm. And I would also add that we think we’re – we think the quality of the backlog, particularly in HPS when you look at having completed some projects that were intent, bid very aggressively in order to create that installed base as well as the backlog of the service bank that we’ve got, which between the lifecycle services and the advanced solutions, those are nice margin businesses. So all those dynamics kind of give us a sense that we will be facing a little bit of a better environment as we head in …

Nigel Coe - Morgan Stanley

That’s great news. And the ACS short cycle, obviously that’s a big focus area for a lot of investors. How much of that strength is driven by end market recovery? How much is driven by Honeywell gaining the share and in which regions you’re seeing that strength?

Tom Szlosek

Well, I think the -- first of all the strength region wise, the U.S is -- we’re ahead of the GDP growth rate for sure. We are probably low to mid single digits from ACS short cycle business, Europe at least that and Asia double digit. So its -- there is no areas of the portfolio that we’re disappointed and especially giving the market circumstances that we’re dealing with. I’d say it’s a combination of new products and when we continually tout 500 new products a year. There are industrial spaces and building spaces where you wouldn’t necessarily see them. But you can also look at some of the retail stuff that we have. Our thermostat portfolio and I am quite impressed with what we’ve delivered both the product, but more importantly the results that we’re seeing in the retail space. So, I think from an ACS short cycle business I really can’t think of a space that isn’t performing pretty nicely for us.

Nigel Coe - Morgan Stanley

That’s great news. And maybe I can -- couple of more trend questions and we’ll go dig into some of the structural issues.

Tom Szlosek

Yes.

Nigel Coe - Morgan Stanley

Commercial aftermarket you mentioned strong. It's been weak, it's getting better. What's driving that recovery? Is it inventories are airlines doing more overhauls, where are you seeing that pickup in activity?

Tom Szlosek

Well, I mean this is a little bit of a first step second half story and the comparisons really have to be bored in mind on this one. And when you look at 2011, 2012 the growth rates that we had in the Aerospace aftermarket I mean I was in ACS at that time and I was so happy that aero was delivering like they were. So, you had close to 20% growth in the aftermarket portfolio in 2011, not quite as robust in 2012 but still very strong. So reaching those growth rates was challenging in the first half. But the comparables get a little bit more forgivable in the second half. So that’s a little bit about what you’re seeing there. And I also think we’re coupling back up with flight hours, and the other thing is the offerings that we have particularly on the BGA side around the replacement units, the RMU’s. We’re getting great pickup to take up on those, continued to get some really nice activity there.

Nigel Coe - Morgan Stanley

And then finally Defense and Space was down 8% in 2Q, tough quarter for Defense and Space. You’re looking for down 4% in 2013, so second half gets better; gets a little bit better, are you still seeing that improvement?

Tom Szlosek

Yes, I mean we’re holding to what we said at the second quarter earnings release. Yeah its tough environment, but the good news for us is that we’re very diversified when you look at the U.S. Government budget. We’re not on any one single program that’s going to tank the business A. B; there’s quite a bit of exposure outside of the portfolio or outside the U.S. in that portfolio and that continues to grow for us both either size and the growth rates and in the places that we’re in. So, it's not exactly offsetting what we’ve got but knock on wood hopefully we’ll return to overall growth rates some time, 2014 little bit after that.

Nigel Coe - Morgan Stanley

Okay, good. So the announcement came to us this morning, you closed Intermec finally?

Tom Szlosek

Yeah.

Nigel Coe - Morgan Stanley

Congratulations on that.

Tom Szlosek

Yes. We announced that it in December and here we are in September. Time flies.

Nigel Coe - Morgan Stanley

So obviously SEC put some conditions on closure. Does that change in anyway the appeal of the acquisitions?

Tom Szlosek

Actually it gives us more revenue. We have -- as was announced we have a licensing agreement with Datalogic for the 2D scan engine and it's not going to be a material amount of revenue for us for sure, but it does provide some sharing. But the overall at Intermec acquisition we’ll continue to be enthused, highly enthused by, first the mobility product line really is a step up to our existing portfolio and the number of channel partners that they have, the number of developers that they have is probably 10x what we have, and so their presence in that space is very, very attractive. They’re also in other parts of that scanning mobility space, printing and the voice that are very, very attractive for us and we think we can get some nice sale synergies as well.

Nigel Coe - Morgan Stanley

Okay, one more question for me and then I’ll throw it up into the audience.

Tom Szlosek

Yes.

Nigel Coe - Morgan Stanley

You mentioned $1 billion of M&A spend this year, maybe $1 billion next year. I think some of us -- I think many of us would like to see Honeywell spend a bit more on M&A just given you being so successful. And what's the barrier to do more M&A?

Tom Szlosek

I don’t know if there is anything barrier. I think it's finding the right deal that meets our targets, our return targets. And to do that it has to be in places that we are. Generally speaking for us to do an acquisition we have to be able to get the sales or start the cost synergies. We don’t build sales synergies into the model. So we have to get cost synergies. And to get cost synergies you generally have to be a player in that space. You have to have some operations in that space in order to get leverage. So that's overall, but we have hurdles, we stick to them religiously. We also are disciplined when it comes to walk away from opportunities. There is plenty of, for every one deal that we close there is probably 10 that we walked away from. Not saying all 10 of them we got to the alter and walked away, but at various stages along the way for different reasons mostly to do with returns and with fitting our portfolio, we’ve been disciplined about that. So what does that tell you, it tells you that the acquisitions that we’ve done we’ve done 70 acquisitions or so over the last 10 years. They’re generally speaking in that $300 million to $500 million space. Of course we’ve done a handful of deals that are a lot bigger than that. Well known, well publicized ones for very good reasons. But I think overall there’s -- we don’t really have a desire to change our approach to that at this point.

Nigel Coe - Morgan Stanley

I guess, obviously ACS has had the lion’s share of the M&A capital to date. Do you think Aerospace may -- it sounds like EMS acquisition has gone very well?

Tom Szlosek

Yes.

Nigel Coe - Morgan Stanley

Do you think there’s more scope to do more acquisitions within Aerospace going forward?

Tom Szlosek

Yeah, we have just like ACS we have the full acquisition machine up and running in Aerospace. I mean they have a -- we have a dedicated M&A leader each of the three SPU leaders in Aerospace has this part of their strategic plan, the places in their portfolio they like to augment with either new product investment or acquisitions. So, you’re clearly able to mandate and I would also say that there is a regular pipeline of opportunities that we do review. It's a monthly process. Dave Cote is right in the middle of it and he very much encourages that activity. So yes, I mean it's -- there will be plenty more opportunities for them as the time goes. I would say PMT as well.

Nigel Coe - Morgan Stanley

Yes. All right. Questions?

Unidentified Analyst

Thank you. In your slide, in your presentation you called out some strengthening trends in the short cycle businesses in China. Could you just give us some more color around that, what you guys are seeing there? What the recent cadence of trend has been? What you’re seeing in the end of the year?

Tom Szlosek

Yeah, I mean the first quarter was tough. So I think the overall economy was kind of getting its head around financial backing and what the government measures were going to be. But I think the overall trends have continued with in the commercial building space, residential building space and that tends to pull the ACS type product. The other thing is the -- for us the auto industry has been good and Turbo has benefited significantly from that.

Unidentified Analyst

Tom, one of your peers was on the stage this morning talking about improving trends in commercial construction at least signs of life, improving activity with architects. Have you guys seen similar improvements especially in the U.S?

Tom Szlosek

Well, if we have it's not showing up in our orders rates yet. As I said earlier our backlog is fairly stable. So what we’re executing we’re replacing. But we’re not seeing a significant step up yet. You do hear the tidbits from the field that yeah we’re getting more quotation activity, but in terms of materializing the backlog it's not a big piece yet.

Unidentified Analyst

Just wonder if you might speak about general aviation and one area clearly the market has not recovered has been in business jet, I think it's couple of billion dollars of business for you. When you think when you say next year not so slow as you talk about all your businesses. I’m just wondering is that business very depressed at the moment so that if it's to pick up its meaningful, give us a little context to that.

Tom Szlosek

Yeah, I mean I’ll ask Elena to help me on this one. But on the aftermarket side there is -- we’re seeing a lot of activity in business jets. As I said the RMU’s are doing very nice and the overall aftermarket revenue streams are up, well into the high single digits if not approaching double digits. In terms of the OE side, I think we’re seeing probably lower single digits kind of growth expectation, Elena?

Elena Doom

Yeah, certainly on the general aviation side but if you were to incorporate the whole business and general aviation segment for us we have actually had several years of strong out performance relative to the industry which since the 2008-2009 timeframe has been relatively depressed. We think that our success in the 2011-2012 timeframe we had organic sales growth on the business and general aviation OE side north of 20 plus percent. In large part, against the OE to macro because of our strategy around picking the winners and our positions that we have on some of the longer range business jet family. So, with Gulfstream, Dassault, Bombardier, we have not only increasing content and presence, but also those markets are doing a little bit better or have at least over the last couple of years. But the outlook for business and general aviation OE for 2013 is to grow a little less than what we grew at those 20 plus percent rates but in the high single digit range. And again looking forward to next year we’re going to be publishing our annual business and general aviation purchasing expectation survey in October. We don’t anticipate any significant changes in terms of purchase expectations but we would probably see to Tom’s point some fuller growth in 2014 again against a relatively stable end market, but still continued growth on the aftermarket side with increasing penetration from our HTF7000 engine have us penetrated the field and then of course these – the RMU’s continue to do very well for us.

Nigel Coe - Morgan Stanley

Great. So we’re running a bit short on time. But there is two points very dear to my heart, so I wanted to just raise those before we stop. Pensions, just discount rates are rising generally good news for the sector, you’ve got a slightly different pension accounting and there’s a bit of confusion about how Honeywell kind of -- what impact that has on Honeywell. So could you maybe just – stop the clock today, discount rates, market returns, what would you see see …?

Tom Szlosek

I think you would see a slight tailwind for us at the current discount rates and considering the rate returns on the investment portfolio that we’ve experienced so far. As you know we're in a pension income mode right now. But still to that we get a little bit of tailwind not material. And when you consider the rest of the below segment activity on balance we think that’s pretty flattish from 2013 to 2014 even considering the pension.

Nigel Coe - Morgan Stanley

Okay. So retail you think is flat year-over-year in ’14, the repositioning flat year-over-year?

Elena Doom

I think below the other global line item, yes overall we’re looking at roughly neutral.

Nigel Coe - Morgan Stanley

And then obviously March 2014 is a big month for Honeywell as when you go forward for the new five year plan. You’ve been obviously quite successful with the last five year plans. And I know you’re very involved in the current process Tom, so kind of any changes you think or in terms of the framework, in terms of how you frame the next five year plan?

Tom Szlosek

I don’t think so. I mean it's based on our regular strat process. So as you know every year each business prepares a five year strategic plan. And it obviously becomes the starting point for the following year as AOP, the budget for the year. So, there’s a lot of thought that goes into that strat plan. We take those strat plans and we kind of consider the portfolio as a whole and of course where we think we’re light or too aggressive we’ll make adjustments, but I mean in the businesses we’re in the best position to know their markets and to know what products they have to compete and what’s going on in competitive landscape. They have clear knowledge of their cost base. So it’s getting a little help from corporate, but we are not -- there is not a significant change as we look to the next five years in terms of how we’re putting those targets together. Now Dave will put his own spin on what his expectations are, but it’s the same process.

Nigel Coe - Morgan Stanley

Got it. Good. Tom thanks for the time.

Tom Szlosek

Okay, Nigel. Thanks for having us.

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