Honeywell Continues To Invest In A Faster-Growing, Higher-Margin Future
Summary
Honeywell has remained consistent to the vision management laid out for a higher-growth, higher-margin company, and has acquired Transnorm for a little less than $500M.
Transnorm has a strong presence in conveyance systems used to automate warehouses, distribution centers, and other logistics/fulfillment facilities, and particularly in the e-commerce space.
Between growing opportunities in automation and safety, complementary opportunities in refinery catalysts, and the aerospace cycle, Honeywell still looks like an attractive name to hold in the multi-industrial space.
Honeywell (HON) management has made no secret of its game plan for the future, nor its desire to be a leader in markets with above-average potential for revenue growth, margins, and returns on capital. In keeping with that plan, the company has already spun out Garrett Motion (GRX), will be spinning out Resideo, and just announced another promising acquisition for its warehouse automation business.
Between its very strong process automation business, its rapidly-growing warehouse automation business, underrated operations in specialty materials/chemicals and safety, and a solid (if generally well-understood) aerospace business, I find it hard not to like Honeywell. Valuation is not exactly low, but with the company consistently repositioning itself toward higher-growth, higher-margin businesses, and particularly ones where it’s establishing strong market share, I continue to like Honeywell as a long-term holding.
Adding More Warehouse Automation Assets
Honeywell recently announced that it would acquire Transnorm for a little under $500 million in cash, buying the business from a private equity owner.
Transnorm focuses on engineered conveyor solutions and offers a wide range of conveyor belt systems and solutions for moving products through warehouses, distribution centers, and other logistics facilities. Around 80% to 90% of Transnorm’s revenue comes from e-commerce-related business, and the company has seen its revenue growth accelerate from the low-to-mid teens in recent years to 30% expected growth in 2018 as more and more companies automate their warehouse and fulfillment operations to reduce their operating costs and keep up with ever-increasing e-commerce volumes.
Assessing Transnorm’s position/scale in the market is tough, largely because the data on conveyors and conveyor systems is noisy. In many cases the revenue generated by companies like Transnorm is blended together with that of companies like FLSmidth (OTCPK:FLIDY) and Fenner (acquired earlier this year by Michelin (OTCPK:MGDDY)) that supply conveyor systems for mining, or companies that focus on systems aimed at manufacturing production lines. As far as I can tell, though, Transnorm does have a meaningful presence in the warehouse/logistics side of the business, and I’d note the installed base of more than 160,000 units.
Honeywell is paying multiples similar to what it paid for Intelligrated (around 12x EBITDA), and is likewise getting a company with meaningfully higher margins (EBITDA margins around 35%) and revenue growth prospects than its corporate average. Admittedly, $41 million in near-term EBITDA is not going to make much of a dent in a company with roughly $7,500 million in post-spin-off EBITDA, but like Intelligrated this is an opportunity to improve a fast-growing business (warehouse automation) where Honeywell is making a strong land-grab early in the cycle.
Healthy, Growing Demand In Automation
Like Emerson (EMR), Honeywell continues to benefit from healthy demand across almost all verticals in the process automation market. Upstream oil and gas companies continue to boost capex, as do refining and chemical companies, and I believe the high single-digit order growth reported at Emerson is a reasonable proxy for Honeywell, though Honeywell is more focused on midstream and downstream markets relative to Emerson (which is highly leveraged to U.S. onshore upstream oil and gas). Power is a notable exception in terms of its weaker project growth outlook, but even here companies like Emerson and Honeywell are seeing maintenance spending recoveries.
Looking out a couple of years, LNG remains a meaningful potential driver for Honeywell’s process automation business. Honeywell already has a place in more than 40 LNG terminal facilities, with good share in DCS (control systems for process automation), safety systems, and controls. In addition to a $30 billion LNG Canada project, Honeywell could benefit from increased investments in U.S. LNG export capacity. There also are significant downstream capacity improvement/expansion plans at various stages of development in Latin America (including Pemex), the Middle East (including ADNOC), and Asia, and Honeywell’s presence in both process automation (particularly controls and safety systems) and refining technology/catalysts in its UOP business gives it an opportunity to “double dip” in these projects.
Given Emerson’s recent acquisition of GE’s (GE) PLC/PAC business, not to mention other acquisitions in the automation space, I do wonder if Honeywell has any plans to change its basic approach to process automation. Warehouse automation certainly qualifies as a sort of hybrid automation, and Honeywell has made it clear that it sees this as a key long-term growth opportunity that it is willing to support with M&A investment. I’m not so sure, though, that Honeywell is eager to invest elsewhere in controls or instrumentation for more discrete/hybrid automation markets, though I could see more investments in industrial software as consistent with the company’s long-term growth/margin focus.
The Bottom Line
As I said before, the acquisition of Transnorm doesn’t really represent a change in the trajectory of Honeywell’s business as much as it is a reaffirmation of where the company’s growth and M&A investment priorities still lie. Warehouse automation remains a significant long-term growth opportunity, and Honeywell has made it clear that they want to be a first mover and secure a strong market presence before other automation companies even really get moving (though ABB (ABB) has made some recent investments).
I believe these ongoing investments in automation and software are net positives for the long-term valuation potential for Honeywell. With better growth, margin, ROIC, and free cash flow generation prospects than the businesses it is discarding, Honeywell’s overall profile is improving (even if somewhat slowly) and that should ultimately be reflected in higher relative multiples. I can’t say that Honeywell is significantly undervalued on its near-term financials, but I do agree with the vision Honeywell is pursuing and I believe this is still a high-quality long-term investment option, even with some risk/vulnerability to sector-wide and market-wide re-rating.