Image Source: Jeff Turner
General Electric continues to struggle, but its first quarter earnings report came in better than expected as demand across many of its business was positive. We still have no interest in shares. Meanwhile, Honeywell continues to power ahead as it raised its top- and bottom-line guidance for the full year 2018, reflecting a similarly positive demand profile.
By Kris Rosemann
General Electric Gets a Boost
Embattled industry giant General Electric (GE) continues to work to change its fortunes, and strong demand in a number of its businesses helped the company to beat lowered expectations in the first quarter of 2018, results released April 20. Shares received a nice boost on the news, too, but expectations have been quite beaten down. GE’s Aviation, Healthcare, Renewables, and Transportation segments were all areas of strength in the quarter, but Power and Oil & Gas continue to be sources of weakness.
Total revenue grew 7% on a year-over-year basis in the quarter, and adjusted earnings per share jumped to $0.16 from $0.14 in the year-ago period. Adjusted GE industrial operating margin expanded 60 basis points, and adjusted GE industrial free cash flow improved but still came in at roughly negative $1.7 billion. The company continues to work towards its goal of $20 billion in divestitures in 2018-2019 (it may sell its rail business to Wabtec), and it is still facing challenges from legacy businesses in its discontinued operations as it recorded a reserve of $1.5 billion related to a WMC FIRREA investigation over allegations that GE Capital violated subprime mortgage laws prior to the Financial Crisis. Nevertheless, a robust backlog of $341 billion as of the end of 2017 means it top line has a large degree of resiliency.
GE continues to optimize its cost structure, and it reduced industrial structural costs by $805 million in the first quarter, putting it on track to exceed its 2018 cost reduction goal of $2 billion. Management reaffirmed its guidance for 2018; adjusted earnings per share are expected to be in a range of $1.00-$1.07, and industrial free cash flow is expected to be $6-$7 billion. The company has some ground to make up for following negative free cash flow generation in the first quarter, and our Dividend Cushion ratio of 0.1 is reflective of how confident we are in GE’s ability to meaningfully ramp its free cash flow generation back to robust levels. Our fair value estimate sits at $20 per share, and shares yield ~3.4% as of this writing.
Honeywell Hikes Guidance
Honeywell (HON) is off to a strong start in 2018 as its first quarter report, released April 20, revealed solid organic sales growth of 5% over the year-ago period. Strong demand in commercial aviation for original equipment, the US defense market, sales and order growth in Intelligrated (its warehouse automation business), and short cycle process automation were all drivers of the organic growth in the quarter. While GE continues to struggle to right the ship, Honeywell seems to be executing very effectively and is becoming a software-industrial leader as we march forward to “The Next Industrial Revolution” that is the Industrial Internet of Things.
The company was able to expand its segment margin 40 basis points in the first quarter thanks to its Commercial Excellence efforts and the Honeywell Operating System, which led to material productivity and volume leverage. Earnings per share excluding separation costs (it is preparing to spin-off its Transportation Systems and Homes business by the end of 2018) jumped 14% from the year-ago period to $1.95, and free cash flow excluding separation costs jumped 30% to ~$1 billion, nearly double cash dividend obligations of $556 million in the quarter. Honeywell’s Dividend Cushion ratio checks in at 2.6 as of the most recent update, and shares yield ~2% as of this writing. Net debt was ~$8 billion at the end of the first quarter.
Management took the opportunity after its strong first quarter to raise guidance thanks to its healthy demand outlook and confidence in its execution. Organic revenue growth in 2018 is now expected to be 3%-5% (was 2%-4%), earnings per share guidance has been raised to a range of $7.85-$8.05 (was $7.75-$8.00), and the lower bound of free cash flow expectations was raised by $100 million to bring guidance to $5.3-$5.9 billion.
We have been impressed by Honeywell’s ability to execute effectively, and its businesses have been helped along the way by a strong demand profile. The company is well-positioned to take advantage of GE’s recent missteps, and the Industrial Internet of Things represents a meaningful opportunity for it to continue this trend, as evidenced by the positive trends in its warehouse automation business and progress in its transition to a software-industrial leader. Shares are trading in the upper half of our fair value range as of this writing and at nearly 19 times the midpoint of management’s 2018 earnings guidance. Our updated fair value estimate for shares currently sits at $148.
Related: XLI, WAB
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Kris Rosemann and Brian Nelson do not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies. Majority Valuentum owner Elizabeth Nelson has exposure to Honeywell in her retirement account.