Brief History of Company
Honeywell International Incorporated (HON) is a diversified technology and
manufacturing company that currently trades on the New York Stock Exchange. It
provides customers worldwide with aerospace products and services, control
technologies, automotive products, power generation systems, specialty chemicals, fibers,
plastics, electronic and other advanced materials. The company has four aggregated
business segments in which they perform their operations: Aerospace Solutions,
Automation and Control, Performance Materials and Power, and Transportation Products.
Honeywell can trace its roots back to 1885 when it was founded and shaped by
inventive technical people and superior leadership. These same values power the new
Honeywell, which captures the best of its AlliedSignal and Honeywell Inc. heritage, and
is ideally positioned to be one of the world's leading enterprises well into the new
millennium.
You can't see most of their products, but Honeywell claims you can count on
them. Your safe flight might depend on Honeywell’s collision avoidance and traffic
control systems, wing ice and wind shear sensors, autopilots and landing systems. Their
control systems keep your home and office at just the right temperature. Their chemicals
for pharmaceuticals help safeguard your health. Their space-age fibers make body armor
bullet-resistant. And, as leading makers of safer substitutes for CFCs, they help protect
the earth's ozone layer. Their abundant number of products helps people worldwide day
after day.
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Ratio/Dupont Analysis
Many investors and security analysts use fundamental analysis in order to assist in
making buy and sell decisions for individual stocks. This section will demonstrate the
use of fundamental analysis in the examination of Honeywell’s accounting statements
and other financial and economic information to assess the economic value of their stock.
This section will concentrate on a ratio analysis concerned with five important attributes
or characteristics of Honeywell: liquidity, efficiency, financial leverage, profitability, and
market value. Common size balance sheets and income statements are used as a measure
of comparison between Honeywell and GenCorp Inc, one of their primary competitors in
the conglomerate industry.
To commence the analysis I will begin with liquidity ratios which are computed
in attempts to measure the ability of a firm to meet its most current obligations
(Brigham). By looking at the current ratio one can measure the extent at which short
creditors are covered by short-term assets. For 1999 the current ratio was 1.2599, for
2000 it was 1.4778, and 2001 it was 1.59.Therefore, current assets were 1.2599, 1.4778,
and 1.59 larger than current liabilities respectively. This shows that liquidity has
improved over the three-year time span. When comparing it to the industry average of
1.49 one can infer that Honeywell has better liquidity. When comparing it to the
GenCorp’s 2001 current ratio of .90, one can conclude that Honeywell is much more
liquid then its competitor.
In order to obtain a better liquidity measure, one may also use the quick ratio
when it is believed that inventory should be removed from current assets due to bad
inventory. The quick ratio for 2000 was .8445 and for 2001 was .9602. Again, even after
withdrawing the inventory account, there is evidence of improving liquidity. Once again,
Honeywell proves to be more liquid than the industry average of .73 and GenCorp’s .50.
One final measure of liquidity may be found by calculating the working capital
ratio, which measures the firm’s potential reservoir of cash. For 2000 and 2001 the
working capital ratios were .09138 and .13692 respectively. Once again, the increase in
the solutions value informs the investor that the firm is increasing in liquidity. It is also
superior to the industry average of .089 and GenCorp’s .07.
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As an investment analyst it is imperative to focus not only on liquidity but also
factors that affect the efficiency of a company. Asset management ratios show the degree
of effectiveness of managing assets and whether the level of the assets is properly related
to the level of operations as measured by sales. To measure efficiency one may calculate
an inventory turnover which demonstrates the utilization of inventory (Brigham). The
inventory turnover for the years 2000 and 2001 were 6.9074 and 6.7013 respectively.
The decrease in the amount of inventory turned around in a year signifies that Honeywell
is generating less money per dollar of inventory. This may be due in part to the fact that
inventory is increasing throughout the years, in 2000 the dollar amount of inventory was
$3,436 million, while in 2001 it was $3,734 million. Moreover, Honeywell still proves to
have a better inventory turnaround compared to GenCorp’s 6.66 and the industry average
of 6.24.
One can also utilize the average collection period to view the length of time taken
to receive cash on a credit sale. After calculating Honeywell’s average collection period,
it became evident that the collection period increased from 59.09 days in 2000 to 66.23
days in 2001. Receivables are increasing per volume of business and credit policy is
becoming less stringent. Bad debts may be increasing as well as financing cost. This
may put a downward pressure on profitability but because a tight credit system does not
exist, it allows for a greater amount of sales and less inventory costs.
Another potential ratio is the fixed asset turnover ratio which takes into account
sales and net fixed assets. In 2000 it was 1.811 and in 2001 it was 1.724. Because the
number decreased throughout the year it is evident that fewer sales are generated due to
the efficient use of fixed assets. The decrease in the fixed asset turnover can be explained
by the increase of investment of fixed assets. In the future, Honeywell claims that it will
use these assets efficiently to generate sales. Although there is a decrease, Honeywell still
proves to be above the industry average of .53 and GenCorp’s fixed asset turnover of .83.
The total asset turnover is yet another measure of asset management and
efficiency that includes sales and total assets. For the years 2000 and 2001 the values are
equal to 1.008 and .9939. Although these numbers are relatively stable, there are
consistent with the interpretation results of the two asset management ratios above.
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The third category of financial ratios used is the measure of Honeywell’s financial
leverage, or the extent to which it uses its debt financing. The debt ratio can be used to
measure the percentage of funds provided by creditors (Corrado). For 2000 it was
48.04% and for 2001 it was 49.28% therefore remaining relatively stable. Honeywell
performed better than the industry average of 52% and GenCorp’s 53%. Creditors prefer
low debt ratios because the lower the ratio the greater the cushion against creditor’s
losses in the event of liquidation. On the other hand, stockholders may want more
leverage because it magnifies expected earnings.
One may also focus on the ability to pay interest, which can be found using the
times interest earned ratio. TIE ratio measures the extent to which operating income can
decline before the firm is unable to meet its annual interest costs. Honeywell’s interest is
covered 6.2 times. Since the industry average is 6.0 times and GenCorp’s TIE ratio for
2001 was 3.2 times, Honeywell is covering its interest charges by a relatively good
margin of safety. Thus this reinforces the analysis of the debt ratio that Honeywell would
not face difficulties if it attempted to borrow additional funds.
The forth section being analyzed is profitability, the net result of a number of
policies and decisions of Honeywell. The ratios examined provide useful clues as to the
effectiveness of their operations in conjunction with the effects of liquidity, asset
management, and debt. The profit margin on sales gives the profit per dollar of sales.
For 1999-2001 the percentages are as follows: 15.40%, 15.083%, and -.0041%. Based on
the results it is evident that Honeywell faced serious problems in this area during 2001.
This resulted because costs were too high. High cost, in turn, occurred because of the
inefficient operations due to the effects of decrease in air travel due to the events of
September 11th. Honeywell’s Aerospace division has suffered due to airline cutting
capacity and reducing expenditures. This problem holds true throughout the
conglomerate industry, where the average is around 16% but dropped dramatically during
the quarter following the attacks.
Ultimately, the most important or “bottom line” accounting ratio is the ratio of net
income to common equity which measures the return on common equity (Brigham). For
1999- 2001 ROE was 21.22, 23.12, and 10.05%. The industry average is 12.00 and
GenCorp’s ROE’s for 1999–2001 were 18.2, 17.3, and 17.67. Honeywell seemed to
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perform well along with the industry average until 2001 and fell slightly below its
competitor. This can be explained by taking into consideration the current bearish state
of the economy and the pause in industrial activity because of capital spending
constraints. Stockholders invest to get a return on their money, and although this ratio
claims that Honeywell is not doing so well in the accounting sense, companies
throughout America are experiencing the same tribulations.
The last division of ratio analysis is market value ratios, which relate the firm’s
stock price to its earnings cash flow, and book value per share. These ratios give
management an indication of what investors think of the company’s past performance
and the future prospects. If the other four categories all look high, then the market value
ratios will also be high, and the stock price will probably be as high as can be expected.
Two important ratios are the price earnings ratio, which shows how much investors are
willing to pay per dollar of reported profits and the price/cash flow ratio, that is often
evaluated because the stock price may be tied more closely to cash flow rather than net
income. Honeywell’s P/E ratios for the years 1999-2001 are 13.2, 14.3, and 16.4.
Honeywell’s Price/cash flow ratios for the years 1999-2001 are 35.65, 36.02, and 37.36.
In comparison to GenCorp’s P/E ratios of 4.23, 3.43, and 5.19, and price/cash flow of
1.1, 2.3, and 2.94 (and an industry average of 18.0), Honeywell’s growth prospects are
greater and above average and its risk is below average.
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Valuation
When determining the appropriate intrinsic value of Honeywell’s 815 million
shares of stock outstanding, it is suitable for this mature company with a stable history of
growth to use the constant growth model. Expected growth rates vary somewhat among
companies, but dividend growth for the most mature firms is generally expected to
continue in the future at about the same rate as nominal gross domestic product
(Brigham). In order to determine the required rate of return to value stocks I used the
Capital Asset Pricing Model. Using Honeywell’s beta of 1.17, the risk free rate of 1.35%
(based on the t-bill rate) and the return on the market of 9% (the market average over the
past 75 years), the required rate of return for Honeywell’s stock is 10.2835%.
Using Honeywell’s reported dividend growth rate of 8.2% the expected dividends
for the years 2002, 2003, 2004 are .8115, .8780, .95 respectively. This was calculated by
taking the last dividend paid ($0.75) and multiplying it by one plus the growth rate.
Furthermore, the value of Honeywell’s stock is equal to next years dividend
divided by the difference of expected return and the growth rate. If this stock was held
for three years and then sold after the third year the intrinsic value of Honeywell is
$45.59. Based on this information, being that its current price is $20.04, an investor
might want to take this opportunity to purchase Honeywell stock because it is currently
undervalued.
As an investor, one might also want to utilize the Price Earnings Model because it
takes into account the mean PE ratio of publicly traded competitors. Using the expected
earnings per share of 2.69 and the mean industry PE ratio 19.17, Honeywell’s intrinsic
value is $51.56. In accordance with the results from above and their earnings estimates
for 2002 to 2004 being 2.69, 3.09, 3.55, their stock is currently undervalued, signifying a
buy. These results should wet the appetite of investors because Honeywell’s earnings
over the years have proven to be steady, and quite impressive to say the least. Any
investor looking for a good find can not afford to pass these figures up! The earnings
projections are a true indication of Honeywell’s bright future.
Based on my calculations, I found Honeywell’s stock to be extremely
undervalued, however, I attribute this to the pessimism in the current economy. On the
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whole, this great undervalue of Honeywell’s stock makes it an attractive investment,
considering the stock is currently at $20.04. There is unlimited potential and the
likelihood of a nice percentage return should the stock reach its intrinsic value in the next
few years.
HON has a relative safety rating of 1.17. On a scale of 0.00 to 2.00, a relative
safety of 1.17 is good. I examined safety from the viewpoint of an equity investor rather
than that of a purchaser of debt. From this perspective, consistency of financial and
operating performance, stock price appreciation history, and price volatility are the key
factors used in the evaluation of relative safety. Debt to equity ratio, capitalization, sales
volume, business longevity and other factors are also considered, but to a lesser degree.
For the more risk adverse investor who favors steady predictable performers a stock with
a relative safety greater than 1.00 (like that of Honeywell) is safer and more predictable
than the average of all stocks. A stock with a relative value less than 1.00 is less
predictable and riskier than the average stock.
Overall, as an investment analyst for a securities firm I would recommend
Honeywell as a relatively low risk buy that will provide an investor with good returns in
the future. Because of the September 11th attacks, the retrenchment in the airline
industry, and a delayed economic recovery, Honeywell has suffered in its sales for the
end of the 2001 fiscal year. Although it has suffered, this strong company shows no signs
of insolvency. As it was since the formulation of the company, and continues on till the
present day, Honeywell’s management is dedicated to the company’s future. The future
looks positive and bright for this Aerospace giant, and now is the time to get in on its
stock. If you are currently invested in Honeywell’s stock and are questioning whether to
hold or to sell, I recommend hold. Honeywell’s stock, along with various companies
worldwide, are suffering as a result of the economy. I believe that the lesson in the past
few years is that you have to be a long-term investor. If you abide by this lesson and
purchase (or hold) Honeywell there is a large possibility of good returns in the future.
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