Honeywell International $HON Q4 2022 Earnings Call

Thanks, Vimal, and good morning, everyone. Given the backdrop Vimal just shared, in total for 2023, we expect sales of $36 to $37 billion, which represents an overall organic growth sales range of 2% to 5% for the year. While we'll continue to drive pricing actions where needed to offset the impact of cost inflation, we expect more balance between the contributions of volume and price in 2023. Similar to last year, we believe the first half of the year will be slower as supply chains improve sequentially throughout the year and potential headwinds from the reversal of zero-COVID policies in China are strongest in the first quarter. In Aerospace, the demand backdrop remains very encouraging in both commercial aviation and defense and space. In the commercial aftermarket, we expect continued flight hour growth, particularly in widebodies as international borders open and travel further normalizes, to drive growth in air transport aftermarket sales. The policy change in China should provide added fuel to this dynamic. On the commercial OE side, build rate schedules among the OEMs are trending upwards year over year, leading to more shipset deliveries for Honeywell, driving revenue growth but also translating into a corresponding increase in selection credits ahead with some margin pressure. In defense and space, we plan to convert our strong order book into sales and expect defense to return to growth in 2023 as the supply chain improves. Supply chain constraints, not demand, remain the gating factor to both commercial and defense volume growth in 2023, but we're encouraged by the improvements our team has executed in recent months, resulting in 7% output growth in 2022. The sourcing environment for electronic components in Aero improved over the past quarter, but the supply chain for mechanical components remains constrained due to skilled labor shortages among tier three and four suppliers. We entered 2023 with Aerospace backlog levels that are more than 20% higher year over year, giving us confidence in our growth projections. For overall Aero, we expect organic growth for the year to be in the high single-digit to low double-digit range. While Aerospace will likely be our strongest top-line grower in 2023, we expect only modest margin expansion year over year as increased volume leverage is largely offset by unfavorable mix due to increased selection credits in the commercial OE business. In Building Technologies, we're cognizant of the broader economic environment and expect private investment in non-res construction to continue to be impacted by increased financing costs. However, throughout 2022, we've built a strong slate of orders, partially as a result of the supply chain environment, that provides solid sales visibility and buffer for 2023. In addition, we believe that institutional investment will remain robust, buoyed by government stimulus funds that have not yet been deployed, supporting key verticals such as education, airports, and healthcare. We see the most significant sales growth this year coming from building projects and building management systems as we capitalize on a robust 2022 book-to-bill in these businesses. We also expect increased spot orders for our building services throughout the year as the supply chain normalizes, layering incremental demand in. For overall HPT, we remain cautious in the current environment, expecting our strong backlog to support us early in the year and anticipate low single-digit organic sales growth for 2023 overall. However, we remain very confident in our long-term framework for Building Technologies, as much of our portfolio is aligned with secular trends of sustainability and energy efficiency. On a segment margin basis, we expect to carry the momentum from 2022's strong exit rate, resulting in year-over-year expansion for the full year. In PMT, we are set up to build upon an impressive 2022 and convert favorable macro conditions into another solid year with sales growth sequentially throughout the year. Backlogs built through 2022 will enable another year of growth in process solutions, led by lifecycle solutions and services and thermal solutions. In UOP, improved comps as we lap the lost Russian sales headwinds will provide support to a business that already has potential for upside. Our process technologies business returned to growth in the fourth quarter and is poised to continue to grow in 2023, while catalyst shipments should remain robust throughout the year. Demand for new energy capacity to offset lost Russian supply will also be a tailwind, particularly for our LNG business. In advanced materials, growth will continue despite difficult comps thanks to strong demand for our Solstice products and supply chain improvements. In addition to Solstice, our other sustainable offerings will benefit from legislation such as the Inflation Reduction Act and increased customer focus on environmental responsibility. Orders in our sustainable technology solutions business have accelerated dramatically over the past two years, and we're expecting more of the same in 2023 as we continue towards our $700 million sales target by the end of 2024. In total, we expect PMT sales to be up mid-single digits for 2023. PMT margins should expand modestly as a result of improved volume leverage and continued pricing and productivity actions. Turning to Safety and Productivity Solutions, that will be the business most impacted by the macroeconomic environment in 2023. In Intelligrated, decreased investment in new warehouse capacity will continue to limit near-term opportunities in our long-cycle projects business, with the trough in demand likely coming this year before we turn to growth in 2024. However, our aftermarket services business has been growing at double-digit rates, and we expect that to continue in 2023. In productivity solutions and services, short-cycle demand softness and distributor de-stocking will impact sales in the first half of 2023, but we expect this dynamic to taper off and should see sequential improvement later in the year. In sensing and safety technologies, sales growth will continue in 2023 after a strong finish to 2022. In total, we expect SPS sales to be down mid- to high single digits for the year. From a margin standpoint, 2023 should be another solid year for SPS as we continue to benefit from improved business mix and drive our operational improvements. While 4Q22 is a high-water mark for the business and will not necessarily be the new standard moving forward, we believe high-teens margin rates are achievable in 2023. So we expect our overall segment margin to expand 50 to 90 basis points next year, supported by higher sales volumes, our continued commercial excellence efforts, and productivity actions. Similar to last year, we expect SPS margins to expand the most as we build on our operational improvements in 2022 and continue to benefit from improved mix and cost structure in that business. For the year, we expect earnings per share of $8.80 to $9.20, flat to up 5% adjusted, despite an approximately $0.55 headwind from lower pension income. Absent this impact, our adjusted EPS range would have been $9.35 to $9.75, up 7% to 11% adjusted. On the free cash flow front, we expect a range of $3.9 to $4.3 billion in 2023, or $5.1 to $5.5 billion excluding the one-time $1.2 billion net impact of NARCO, HWI, and UOP matters. I'll walk through the puts and takes for our 2023 cash flow in greater detail in a couple of minutes, but first let's turn to slide seven and walk through our EPS bridge for 2023. As you can see, segment profit will be the key driver of our earnings growth in 2023, contributing 59 cents at the midpoint of our guidance range. Net below-the-line impact, which is the difference between segment profit and income before tax, is expected to be in the range of negative $475 million to $625 million, which includes capacity for $200 to $325 million of repositioning, which is lower than the approximately $400 million we used in 2022. For tax, we expect an effective tax rate of approximately 21% for the year. With these inputs, below-the-line and other items excluding pensions are expected to be a 5 cents per share year-over-year headwind at the midpoint of guidance, primarily driven by lower repositioning and asbestos charges, partially offset by higher net interest expense. For share count, our base case for 2023 is that our minimum 1% share count reduction program will result in a benefit of approximately 15 cents per share, reducing our weighted average share count to approximately 672 million from the 683 million in 2022. As we previously communicated, we expect a large decline in pension and OPEB income this year as a result of the increased interest rate environment. For the full year, we expect approximately $550 million of pension and OPEB income, down about $500 million from 2022, driving about a $0.55 headwind to EPS. However, this is a non-cash accounting item, as our overfunded pension status will ensure that no incremental contributions are needed. We ended 2022 with a pension-funded status of over 125%, a result of diligent management and strong returns, a great position to be in for our employees and shareholders. In total, we expect 2023 earnings per share to be in the range of $8.80 to $9.20, flat to up 5% year on year on an adjusted basis. However, excluding the impact of non-cash pension headwinds, our guidance would be a range of $9.35 to $9.75, up 9% at the midpoint. Now let's turn to slide eight and talk about the drivers of our free cash flow guidance for 2023. As we've outlined in the bridge, our 2023 free cash flow story can be characterized as strong operational performance offset by a few discrete non-operational items. Income growth is the largest driver of free cash flow, and we expect to make further progress this year on working capital as the supply chain normalizes. We expect 2023 free cash flow, excluding the settlement of the legacy legal matters we discussed earlier, to be a range between $5.1 to $5.5 billion, up 8% year over year at the midpoint, as we had previously spoken about. Accounting for the settlements, we are expecting free cash flow for 2023 in the range of $3.9 to $4.3 billion. Now let's turn to slide nine where we can discuss our guidance for 1Q. As we highlighted earlier, we entered 2023 with record backlog, providing a solid foundation for the first quarter. Supply chains remain constrained, however, we anticipate modest sequential improvement in volumes. We're closely monitoring the impacts of zero-COVID policy changes in China as the country reopens and eases its COVID restrictions and are wary of potential 1Q impacts. However, we anticipate that these policy changes will be a net positive for demand as we progress throughout the year and will result in a robust second half in China. Looking at the segments, we expect sales growth in Aerospace in the first quarter as the demand environment remains robust and we execute on our strong backlogs. However, the rate of growth will be more subdued than our full-year expectations as we anticipate 1Q will be the most supply-constrained for the quarter. In Building Technologies, we anticipate modest organic sales growth in the first quarter as we work through our backlog and the supply chain continues to heal. We see the strongest sales growth in building projects, followed by increased sales of fire. In PMT, we expect another quarter of year-over-year growth in 1Q. We expect that growth to be once again led by advanced materials with process solutions the latter of those filled with strong year-over-year growth. We're expecting, or sorry, we experienced a disruption in one of our PMT plants that will cause some unplanned downtime, so that is embedded in our guide. In Safety and Productivity Solutions, short-cycle and warehouse automation demand softness will offset growth in Intelligrated aftermarket services and the sensing part of our sensing and safety technologies business, leading to a decline in year-over-year sales. However, we expect another strong margin performance in the high teens. So for overall Honeywell, we anticipate sales in the range of $8.3 to $8.6 billion in the first quarter, up 1% to 5% organically. We've set margins in the range of 21.4% to 21.8%, up 30 to 70 basis points year over year, as we remain diligent in our price-cost management and benefit from favorable business mix. The net below-the-line impact is expected to be between $165 to $210 million of an expense, with a range of repositioning between $80 and $120 million as we continue to provide capacity to fund our transformational efforts. We expect the effective tax rate to be in the range of 21% to 22% for the quarter and the average share count to be approximately 675 million shares. As a result, we expect first-quarter EPS between $1.86 and $1.96, down 3% to up 3% year over year, or up 5% to 10% excluding the year-over-year impact of lower non-cash pension income. And lastly, while the first quarter is already historically our lowest from a free cash flow perspective, the settlement payments related to the aforementioned legal liabilities were paid out in January, and we expect cash from operations to be a net use in 1Q. Overall, while we maintain a prudent level of caution, we're confident in our operational abilities and our portfolio of differentiated technologies. Our portfolio is well positioned for this

stage of the cycle and will continue to innovate and invest in the businesses to support long-term growth. Now with that, I'll turn the call back over to Darius on Slide 10.

Hey, thanks, Julian. First off, we don't guide orders, so we're not really going to comment on that specifically. As it relates to the margin outlook you highlighted, I think you're in the right neighborhood. Again, we don't guide our individual margin rates for each of the segments, but to expect that Aerospace might be down in 1Q is probably a reasonable expectation. And as I highlighted, SPS is going to be on the top end of our margin expansion all year long, frankly, given all the work that team has done adjusting their cost structure for the realities of the sales environment that they've been in, as well as we talked about before, the reductions in celebrated sales are actually not painful from a margin standpoint; they actually help given the margin profile of that business. So I think your instincts are right, but we're not going to be specific on that guide.

Yeah, I mean, we absolutely are. I think that we're very committed to that number. As we look at the outlook for this year, we're very much within our operating algorithm that we provided last Investor Day. If you just take the midpoint, we're sort of at the lower end on revenue, but we have to evolve our margin profile. But in terms of our commitments to our long-term gains, it's very much on track. The OEM credits are significant as a headwind, and think about that, that is tied to Boeing's delivery specifically of airplanes and incentives that we have with the airlines who are taking those airplanes. And that is going to be a multi-year realignment. Today, they've promised in excess of their production rate in terms of deliveries, and so that's what's going to move the needle. It's going to impact our sales. When we print our OE sales growth rates, you're going to see that as an offset, and it's obviously a margin headwind. So it's measured in the hundreds of millions of dollars. We're not going to be precise about what that is, and again, there's going to be variability around that depending on the actual delivery performance of the OEMs to the airlines themselves.

Yeah, I mean, all I would say is where that means rather than double-digit price increases, we're planning on mid-single digits, maybe low single digit year with inflation in that same neighborhood. And I think that's important, is that we just don't do pricing blindly. I mean, you can watch demand versus pricing versus balancing our inflation, and we try to do that thoughtfully such that it's not just blind increases. We also have to be mindful of market share, demand, etc. And we've got a set of analytics to do that. I mean, this is the power of Honeywell Digital, which we've been implementing the last three to four years. Our level of visibility and accuracy is actually really good, and it's a new set of muscles we've developed actually in the last year and a half as we face this inflationary environment.

Can you repeat the last one because I didn't quite get the last question there, Nigel.

Yeah, I think that one was going to be, it's probably too early to tell. But what I will tell you is that for, you know, we already basically demonstrated that we can get to 20% margins in SPS in Q4. So the target hasn't changed. In terms of what's happening overall with the business, you know, Intelligrated, the markets are down. I mean, we see it. The warehouse and distribution segment is down. There's an overbuild that occurred in the year 2020 and 2021. The markets are absorbing that capacity. We do expect an uptick in orders and return to growth in 2024. We actually are encouraged by the pipeline that's starting to form. And at the same time, we also are being a little bit more selective in terms of margin profile and so on. And we have an algorithm in terms of the kinds of orders that we want. So it's a little bit of both. PPS has been a bit softer than in the prior. We've got to remember that we're coming off of record orders, particularly in the first half. But overall, we expect to see a fairly strong, robust level of business in the second half this year, and we still have a backlog to draw from. So I don't think there was anything in SPS in Q4 that was out of expectations. It was actually incredibly consistent, and frankly, I was very encouraged by the margin range. And that team has done a nice job in really managing to the cards that are dealt from a revenue base, using our Accelerator operating system to really deliver a strong financial result.

Yeah, great question, Jeff. And your instincts are on. This is a bubble, right? Because Boeing, in particular, was not able to deliver jets when they were grounded. And so that acceleration is going to go up and then come back down again. As we see it right now, it looks like '23 is going to be the top and then it starts coming back down. But again, that's going to depend entirely on the pace of those deliveries. But it ought to be, let's say, reoriented back with deliveries in our view by 2025 for sure, and maybe into 2024. So this is going to be a temporary headwind, and then things will realign back where deliveries and shipments come back into line, and so therefore our P&L will become more aligned.

Yeah, I mean, I think first of all, let me, there's a couple of questions. And the first one is why is the guidance wider than normal? Because I think we would probably admit that in terms of the economic scenarios this year are probably a bit wider than most people would guess. And you have anything ranging from a soft landing out there to a deep recession, and I've heard opinions anywhere in that range. So I just think from a Honeywell perspective, and this is I think consistent of how we guide every year, and probably this year more than ever, we try to have a little bit of a wider range, which is indicative of the uncertainty around the economic conditions. And I would say if I were to compare this year versus '22 or '21, it's probably more uncertainty rather than less. So that's sort of the reason for the wide range. In terms of the range itself, sure, at the lower end is probably tougher economic conditions. The second half is the economic conditions turn worse, the short cycle is worse than we expect. At the top end, it's a bit more of what we hope is the expectation, which is from the order activity turns, short cycle becomes more robust in the second half, and China returns to growth. I mean, Q1, we actually think Q1 in China could be challenging because of the lifting of the COVID restrictions, Chinese New Year, and so on. And we embedded that in our guide. But we actually think that second half in China could actually be quite strong. And if that comes to fruition, that sort of points to the upper end of our guide. So that's where we kind of have a bit of a wider range. And by the way, we did guide a wider range like this historically at 40 cents. It's not that much wider. And '22 was a little bit narrower, but I think it's just as simple as it's indicative of the economic uncertainty that I think many of us are facing, and there's a wide range of educated guesses.

Maybe I'll start and have Vimal add any further commentary. I would say, no major surprises. I mean, in terms of how we ended up, Europe was softer, but particularly the UK was really soft in Q4. That probably stood out for us in Europe. But then as we looked at December, the exit rates weren't actually bad. So November and October were a bit weaker, December exit rates were better. In terms of the overall business performance, it was actually incredibly consistent of what we guided. I mean, we guided, we came in roughly at the middle of our range, a little bit better on operating margin. I mean, we guide for a reason, and that's sort of where we ended. And by the way, thank you for acknowledging the Resideo. I think as you kind of read the articles and some of the other companies out there, I can't understate how important or overstate how important it is to eliminate liabilities from your balance sheet. And when you can do that permanently with confidence, it substantially de-risks the future of the company. I think maybe this didn't get as much attention as I think it should have because it was a huge deal. It ate up a lot of bandwidth, but I am thrilled to have this liability reduced off the balance sheet.