Honeywell International Inc (HON) — Q4 2024 Earnings Call Transcript

Thank you. Good morning, and welcome to Honeywell's fourth quarter 2024 earnings and 2025 outlook conference call. On the call with me today are Chairman and Chief Executive Officer, Vimal Kapur; Senior Vice President and Chief Financial Officer, Greg Lewis; and incoming CFO, Mike Stepniak. This webcast and the presentation materials, including non-GAAP reconciliations, are available on our Investor Relations website. From time to time, we post new information that may be of interest or material to our investors on this website. Our discussion today includes forward-looking statements that are based on our best view of the world and of our businesses as we see them today and are subject to risks and uncertainties, including the ones described in our SEC filings. This morning, we will review our financial results for the fourth quarter and full year 2024, discuss our outlook for the year, share our guidance for the first quarter and full year 2025, and provide an update on the comprehensive portfolio evaluation. As always, we'll leave time for your questions at the end. With that, I'll turn the call over to Chairman and CEO, Vimal Kapur.

Thank you, Sean, and good morning to everyone joining us today. We finished 2024 on a positive note, exceeding or meeting the high end of our guidance for organic sales growth and adjusted earnings growth in the fourth quarter while navigating an uneven operating environment. During 2024, we deployed over $14 billion of capital, including foreclosed acquisitions for approximately $9 billion, remaining on track to surpass our commitment to deploy at least $25 billion of capital through 2025. We also delivered on our promise to exit non-core lines of business with the planned spin of advanced materials and the sale of our personal protective equipment business in the quarter. Turning to 2025, we're excited by our progress from our future shaping innovations to growing our global installed base. That said, we are aware that the evolving geopolitical situation, challenging global macroeconomic conditions, and tempered demand expectations in some end markets may pressure our near-term momentum. As a result, we are offering a realistic baseline for 2025 performance based on current end market conditions and without assuming a recovery in short cycle demand. While the current operating environment presents some near-term challenges, we continue to believe in the strong through-cycle growth potential of our best-in-class businesses. Now let’s zoom out from the near-term dynamics to discuss an important step in our journey to transform Honeywell. Following our year-long comprehensive business portfolio evaluation, we have decided to pursue a full separation of automation and aerospace technologies. We believe the results of our strategic assessment provide clear direction for the future of Honeywell. Let's turn to Slide 3 to discuss today's portfolio announcement in more detail. As many of you know, Honeywell has performed portfolio evaluation systematically for many years, evaluating various ways to potentially unlock value as conditions evolve. About a year ago, I initiated a process to look even deeper at different structures, including full separation of our largest businesses. Following the completion of this in-depth internal portfolio review, I'm prepared to share with you today that the Honeywell Board of Directors has concluded that the separation of automation and aerospace is in the best interest of Honeywell shareholders. This step, coupled with the previously announced plan to spin advanced materials, will result in three industry-leading public companies with tailored strategies and growth drivers. The formation of these three existing companies will enable greater strategic focus, operational independence, and financial flexibility to pursue growth opportunities, unlocking significant value for our stakeholders, including shareholders, customers, and employees. From a timeline perspective, we expect to complete the separation in the second half of 2026 in a manner that is tax-free to Honeywell shareholders. In between, we remain very focused on delivering on our commitment, and we'll continue to identify ways to further shape our portfolio and create shareholder value. Now let's turn to the next slide to discuss why we think this is the right time to separate into three publicly traded companies. The decisions are based on the operational and digital foundation we have created over the past two decades, and the series of strategic actions we have taken over the past year to dramatically simplify Honeywell. Our excellent operating system is mature and will be a source of strength for each company. Looking ahead, we see increasing divergent strategic pathways for automation and aerospace. This is a logical step to bring the portfolio to the next phase of transformation and unlock incremental value. With that, let's turn to Slide 5 to talk about the strategic rationale behind today's announcement. We believe the planned separation of automation, aerospace, and advanced materials will benefit all stakeholders and position all three stand-alone companies for long-term profitable growth. This separation will enable three pure-play companies to pursue simplified go-forward strategies that are clearly aligned to the unique purpose of each business and to address the specific needs of their end markets. With this clarity of strategy and incentives and enhanced financial flexibility that comes with being an independent company, Honeywell Automation, Honeywell Aerospace, and Advanced Materials will be able to meaningfully drive innovation throughout investment cycles. The distinct investment profile of each company and an improved ability to customize capital allocation strategy will unleash the full potential of each company's strong balance sheet, creating the best path forward for enhanced commercial success, faster-based clinical innovation, and increased customer intimacy. Each business will be able to build on their existing powerful foundation with the guidance of focused board of directors and management teams that have deep domain expertise and a clear vision for their future. We are committed to maintaining a strong investment-grade credit rating for both automation and aerospace and a strong non-investment grade credit rating for advanced materials, positioning all three to compete successfully for capital among their respective peer sets.

Thanks for those kind words, Vimal, it's been a privilege to lead this iconic company alongside you and Darius. And good morning everyone. Honeywell finished 2024 on a strong note, meeting the high end of our organic growth and adjusted EPS guidance in the fourth quarter despite a still challenging macroeconomic environment. Cash flow is also positive, coming in at the high end of guidance in the fourth quarter. Importantly, during the quarter, we announced a landmark agreement with Bombardier, one of the largest business jet OEMs globally, to provide the next generation of technology for current and future aircraft in avionics, propulsion, and satellite communications. This includes the first deployment of our next-gen Anthem avionics at scale and comes with a lifetime value of the partnership of $17 billion. While the related investments lowered our reported performance in the fourth quarter, the long-term economics are compelling and there is no impact on 2025 performance.

Thank you for the support Greg and all your contributions to Honeywell. Let's turn to the next slide. Looking at our major end market exposures entering 2025, we see underlying long-term secular strength being met with near-term challenges in the macroeconomic backdrop and heightened potentials. In aerospace, commercial fleet growth and replenishment continue, and defense investments remain elevated with some natural moderation from the double-digit growth rate seen for the past three years. We benefit from public and private spending on infrastructure projects and ongoing push for more automation investment addressing chronic labor shortages and inflation, but demand for short-cycle products remains muted in the near term.

2024 was a productive year for Honeywell as our portfolio optimization efforts kicked into high gear, and we kept our focus on executing on our commitment and delivering for our customers. While we may have come into last year with too much optimism for a recovery in our short-cycle businesses, we have adapted, demonstrated resilience, and ended the year by delivering organic growth and adjusted EPS results above our targets. We'll continue to do so in 2025. Recognizing the uncertain macroeconomic and geopolitical backdrop in front of us, we will spur growth with innovation and relentless dedication to productivity, and we are focused on delivering on our commitments. While we face an uncertain operating environment, we have incorporated that into our outlook for 2025. Our guidance will serve as a prudent baseline for performance that we have a strong conviction we can achieve with potential upside if underlying demand improves. Further, with today's portfolio announcement, we believe the planned separation of Automation, Aerospace, and Advanced Materials will position all three stand-alone pure-play companies for long-term profitable growth and generate significant value for all stakeholders, including shareholders, customers, and employees. With that, Sean, let's move to Q&A.

Thank you, Vimal. Vimal, Greg, and Mike are now available to answer your questions.

Hi, good morning and congrats on getting the strategic review completed, and thanks, Greg, for all the help and wish you well.

Thanks, Julian.

Maybe just a first question around the separation news. If you could give us any help around the stranded and stand-up costs that might be needed for aerospace and automation initially out of the gate. And also if you could give us any help on the free cash flow conversion or margin profiles of the pieces. We can see that the segment margin color, but wondered if there was anything on the free cash flow differences?

Sure. So maybe I'll start with the free cash flow. So Aerospace should be around 100% free cash flow conversion; the business should be operating at that level. And for our automation businesses, that free cash flow is also expected to be at around 100% free cash flow conversion. So that's what we're aiming for as far as going to this year and then next year.

Regarding your question about stranded costs and one-time costs, you mentioned that one-time costs are estimated between $1.5 billion to $2 billion. This figure may vary based on our structuring efforts, so it's our preliminary estimate, and we will provide updates as we refine our analysis. As for stranded costs, we prefer not to provide a specific figure at this moment since further analysis is necessary. This is why we anticipate completing this evaluation by the second half of 2026 to ensure we have sufficient time to understand and implement the details.

Yes. The only thing I would just add to that, Julian, is we expect to grow into that between the growth of the company and taking those stranded costs over time inside of probably two years; that should certainly normalize itself.

That's right, then just based on our prior experience and everything that we see with advanced materials, that is quite doable, and we see those costs leaving us within 18 to 24 months post spin.

Thanks a lot. And then just a second question would be around the operating segment margin guidance. It's flattish this year. I think it was down slightly, 20 basis points underlying in 2024. I wondered if that had made you think about maybe doing a more aggressive repositioning cost out program in 2025? And if not, kind of why?

Right, Julian. So I would say a couple of things. First of all, I think what we saw in the fourth quarter and the second half, we're quite encouraged by the margin projections and what we expect to see over the next 24 months. If I look at repositioning costs, we're expecting to add about $100 million of repositioning costs this year, year-over-year, which will help fund margin expansion. But the bigger point here is really, if you look at our segments, three segments with exceptional Aerospace will expand segment margins this year, which is quite encouraging. And acquisitions are helping with that, especially in the second half. With respect to aerospace, we are getting a lot of leverage from volume, and that's helping us to expand margins. But in the short term, meaning 2025, the thing that puts Aero on the back foot as far as margin expansion is really the CAES acquisition. In the case of CAES, acquisition from a margin standpoint is dilutive, and this is the first year of acquisition, and we had a lot of integration costs that we have to absorb and move out.

And Julian, this is Sean. Just to remind you, we've said many times that the CAES acquisition, while dilutive to the margin profile in 2025, is going to grow very nicely at accretive rates to aerospace and therefore, will be accretive to segment profit growth in 2025 and beyond.

Thank you.

Good morning.

Good morning.

Hey, good morning guys. There's a lot of puts and takes here. But the first question just to clean up. What are you thinking timing to name the management teams of the pieces? And will there be an external search for aerospace? Or will you build that internally?

So Scott, I would say that we will announce the management teams as time progresses, but we expect the concern Honeywell leadership team to continue. We'll let the Board decide the leadership of RemainCo Honeywell and Honeywell Aerospace. So more to come as we do more work here over the next 12 to 18 months.

Okay. I'm looking at Slide 16. You have $0.52 in below-the-line items and $0.33 in profit contribution from M&A. I believe you mentioned that most of the $0.52 is due to higher interest expense. Did I understand that correctly?

I can break it down for you. Of the $0.52, $0.33 is due to interest expense, mainly from the M&A interest expense. We have $0.10 for additional repositioning, along with a few other items. One significant factor affecting us in the first quarter is the decreased pension income, which stems from the reduction of a pension plan in Europe that we announced last year. Additionally, we are managing about $0.04 in corporate costs. So that's the breakdown of the $0.52.

Okay. So the M&A is a net neutral in 2025 then?

Correct.

We are talking about 1% to 2% accretion for the business in 2025, and that still holds in this guidance.

Hi, good morning and congrats, echoing Julian's congrats to you all.

Thank you. Appreciate it.

So I'm just doing the math on cash. I mean, this year, I think you have like $8.50 a share in free cash as per your guidance, I believe. And that's 83% conversion. Can you just help me bridge to the 100% you just talked about for automation and aerospace? And then I'm just curious, which one of those is going to be the RemainCo?

So I'll answer the RemainCo question. Look, at this point, the specific legal structuring has not been determined. There are both options exist legally. So we'll have to do more work to be more precise. Between the two, we are going to spin aerospace or automation. But they will be separate companies; that's a firm decision.

Sure. So on cash, Steve, we're guiding $5.4 to $5.8, which is not going to be 100%. We're going to work ourselves to the 100% over the next 24 months. And the big unlock in our cash is really working capital, and that's predominantly driven by us being able to reduce and move our WIP and finished goods inventory in aerospace. That's the biggest unlock for our cash as far as getting to 100% over the next 24 months.

Got it. And then what happens to these like below-the-line items like pension income? Does that kind of stay with whatever the RemainCo is and any of those other like environmental liability costs, etcetera?

So we are working our way through it. It's really too early to comment through it, but we obviously have advisers working for those particularities and we'll communicate that as we go through the process and are ready to share this news with you.

Good morning, everyone, and congrats, Greg. Vimal, Mike, whoever wants to take this, but two questions on Aero. First, I guess, if you could provide some end market color, particularly on the aftermarket mid-teens aftermarket growth in 2024. Some of your peers have called out a deceleration to high single digits to low double digits in 2025. How are you thinking about your OE versus aftermarket assumptions for commercial aero in 2025?

Sure. As you know, the hours have stabilized. From an aftermarket perspective, we can expect a similar trend to last year. I anticipate a slowdown due to the stabilization of hours and improvements in the supply chain. Regarding the mix between OEM and aftermarket, we have a significantly higher positive backlog in OEM. Therefore, we aim to continue expanding our OEM and installed base growth. I expect the OEM sector to grow more than the aftermarket over the course of the year. Overall, our outlook remains quite consistent.

And then maybe going back to the margin profile of aerospace. You mentioned better investment decisions post spin or more refined ones, I guess. Lots of questions around Bombardier, and the payment there was $385 million in Q4. So how do we think about that return on that investment? And any other margin moves we should be thinking about in terms of long-term investments within Aerospace?

So look, the Bombardier agreement is a long-term one. It will show into our revenue streams four years, five years from now, like any other these long-term contracts. So we are super excited about this path-breaking win, both for avionics as well as for the engine. And investments in Aero are going to continue. We are ramping up our investments in R&D because we see more opportunities, and we'll remain active in the M&A market if opportunities are available.

Got it. Thank you.

Thanks, good morning everyone. Just wanted to have another crack at the margin question. So the 10 basis points at the midpoint expansion, so it looks like 100 basis points of M&A dilution at aerospace and then maybe, I think, 80 to 90 basis points of expansion elsewhere in automation. I just want to make sure that math is correct. And maybe just provide some overall kind of quality discussion on which segments do you see above and below that bar?

I would say that your calculations are generally accurate. Much of it will depend on how our short-cycle products perform this year. Currently, we have a diverse project mix, and the acquisitions are also contributing to margin expansion in the second half. We can follow up with more specific details on that. Overall, your calculations are on the right track.

So R&D investment, we mentioned in some of our conversations that we expect that to go up perhaps to dollars but directionally maintain the percentages. But you will see that increase coming up as we publish the results of 2025. And it's a material increase. If it was a few million dollars, I wouldn't have mentioned it. And our goal is to prepare each business for growth in the future while maintaining our margins. And we are maintaining that careful balance. On capital allocation, as Mike mentioned in his comments, we do expect to do $3 billion of share buyback to maintain our share count down by 1%, and we'll remain active in an M&A market across all segments. We have active deals in motion in automation in aerospace and energy. And like any other M&A deal, I can't commit to you when they will happen and if they will happen, but we are going to do hard work to do our best to get some deals done.

Hey guys, good morning. Greg, thanks for all the help. I try not to miss you too much. The first question, and look, I know you guys have a lot going on. So, when you thought about breaking up the company into these three entities, how much thought did you give to potentially breaking things down further because you can make an argument that the automation business could be separate businesses as well? I'm just curious about the thought process behind that.

Thanks, Joe. I mean if you look at it, I've been quite focused on what doesn't fit into Honeywell portfolio. And the portfolio work we have done now by splitting into three companies, Aerospace, Automation, and specialty chemicals. On automation, we believe there are multiple common threads. The one-minute answer is business model; all automation follows the business model of creating installed base and mining that installed base through services and software. Number two, the strategic priorities are very similar. We need to focus upon digitalization and leverage that. That made a common thread between the businesses. And technology and offerings are highly shared between these businesses. The amount of common product code we have, as an example, our core product in building automation, we call it the EBI platform and in process automation called it experience platform. This year, the core of tens of millions of lines. We don't publicly share that earlier, but that's a fact because of the high interdependency of technology. And we are not going to that territory of people and all that because that could be a bit debatable. But I have worked in all businesses; another point just because it's natural given the similarity of these businesses, we do share a lot of talent across that. So there's the conviction that RemainCo Honeywell has a strong binding force.

Got it. Well, that's helpful. Yes, I look forward to the longer version as well. But my quick question on the fundamentals. Look, I know that you guys had a tough comp in ESS from a margin standpoint this past quarter. But I'm trying to just maybe get a little bit more understanding on what drove the margins down this quarter? And fully recognize that there is the refrigerant transition. And so I'm guessing it had something to do with that. But just any color on what happened this quarter on ESS margins.

Yes. So the first one is really the catalyst sales in our ESS business. That's a big driver. And that will actually reverse itself in the second half. Just this project, as you know, tend to be lumpy, and when they happen, they're quite material. So that's the biggest driver. And then other than that, like we talked about, there's a little bit of deceleration going on. And we just still don't have the confidence in our industrial products recovery business, which is short-cycle, and we'll continue to monitor it.

Yes, Joe, Mike is correct about that. Remember, we've discussed this over the years, even when it was PMT, not to get too enthusiastic about the margins in any single quarter, given the significant impact that individual catalyst shipments can have in a given quarter.

Good morning everyone. Greg, thanks for all your help. So just focusing on price versus cost. You mentioned prices normalizing in 2025. And it seems like you mentioned cost inflation a lot really at all of your segments when describing the margin impact in Q4, maybe except for building automation. So could you give us a little more color to what exactly happened? I don't think material costs spiked in Q4. How are you thinking about price versus cost in 2025, especially considering tariffs may impact the business?

Certainly. I would say we had a strong year in terms of pricing last year. To begin with that, this year we expect enterprise-level pricing to exceed 2%. Our pricing strategy will vary based on the specific circumstances within each business unit. This year, our focus has been on creating more options and flexibility with our costs. This will enable us to incorporate additional price increases. Overall, I believe the balance between price and cost will be favorable. However, unlike previous years, we now have greater opportunities to enhance productivity in terms of materials and overall costs.

So, Andy, our aim is to expand our margins while balancing price, cost, and productivity. Unlike the high inflation period of 2021 and 2022, where our only option was to adjust price, we now have a significant focus on increasing productivity as well. We've performed exceptionally well in terms of productivity this year. As Mike mentioned, we're very mindful of how to adjust both factors because we want to achieve price increases alongside volume growth. This will differ by business unit, as some have more opportunities than others. In summary, I expect 2025 to resemble 2024 closely, with similar pricing and potentially slightly higher productivity, which forms the basis of our current guidance.

Helpful, guys. And then Vimal, maybe just a little more color on how you're thinking about revenue growth by geography in 2025. I know you mentioned some headwinds in Europe and China. Should China still be a growth market for you in 2025? And you've talked in the past about strong growth tailwinds in regions such as the Middle East and India. So what are you seeing overall?

Overall, I would say the dynamics have been very stable over the last 18 months. If I look at aerospace business, it's growing globally given how much of past dues we have and the drivers of flight hours. The energy business's growth is less driven by region and more by the timing of the demand for catalysts and new projects. I think in the automation business, we see growth in the U.S. growth in India, growth in the Middle East; those are the regions which have tailwinds. And we continue to see more pressure both in Europe and China. That's one of the reasons in the industrial emissions business; we have guided low single-digit downward progression because that has the most exposure to China and Europe in Honeywell's portfolio. So I would summarize that. Our current guide is assuming more of the same. We are not counting on any European recovery. We are not counting on any China recovery in context of automated businesses.

Thank you, good morning everyone and Mike, congratulations.

Good morning.

I wanted to just revisit the credit ratings and leverage targets for automation you're saying look for strong investment-grade rate and just kind of tack on a leverage range you'd expect? And then just clarify on the below investment grade for Advanced Materials. That's not surprising, but just kind of frame for us what you're expecting there.

Sure. So let me first answer investment area. It will be very high below the investment grade level. So that's kind of towards where we're going towards. And honestly, I cannot comment more right now as far as the remaining two entities; we're going through it. But given where the business is today, they will be investment grade and we'll have a competitive and compelling equity story. So I can leave it at this, at this stage.

Yes, thank you. And just no tariffs got mentioned earlier, but is there anything specific that you have baked in or specifically not baked in for the 2025 guide?

Yes. There are no impacts from tariffs included in the guidance. In terms of tariffs, both China and Canada are not significant concerns for us due to our localized operations and business positioning. We are examining the implications of tariffs from Mexico, and like others, we are considering it, but it is certainly manageable.

I want to thank our shareholders for your ongoing support, and our Honeywell colleagues who continue to enable us to outperform in any environment, and our many customers that work with us to help shape a better world. Our future is bright, and we look forward to updating you on our progress as we execute through our commitment. Thank you for listening, and please stay safe and healthy.