Honeywell Pushing Right Buttons

05/16/2011 1:50 pm EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

While aerospace is picking up, the industrial titan’s automation and controls unit has been the real driving force of late, writes Elliott Gue in Personal Finance .

The S&P 500 Industrials Index has returned 32% since the end of 2009, outpacing its parent index by a comfortable 14 percentage points.

The sector continues to benefit from two key drivers: a cyclical recovery in mature economies and rapid growth, and development in emerging markets.

Thus far, shares of early-cycle companies that produce lower-ticket industrial components and equipment have led the way. Demand for these products has rebounded significantly since the 2007-09 downturn.

But change is in the air. Spending on late-cycle industrial products should continue to pick up as the economic recovery gains steam and customers open their coffers.

Honeywell International (HON) is a diversified industrial conglomerate that should catch a tailwind in 2011.

Its operations are split into four business units: aerospace, automation and control, specialty materials, and transportation.

The aerospace division (38% of 2010 revenue) produces aircraft engines and avionics—navigation systems, weather radar, wind-shear detection equipment, and traffic and collision-avoidance systems. Regional carriers and business jet operators account for the majority of the firm’s engine sales, while the avionics division sells parts and components for commercial, private, and military aircraft.

Honeywell’s first-quarter results suggest that the aerospace unit’s customers have ramped up spending. Sales were up 8% from a year ago, driven by a 28% jump in sales of spare parts and a 25% increase in revenue related to new commercial aircraft.

With airlines expected to invest heavily in expanding their fleets, Honeywell should enjoy quite a boost over the next few years. Meanwhile, carriers are running fuller schedules, so demand for replacement parts and repair services should pick up.

Despite these positive developments, sales of defense- and space-related products languished because of reduced government spending. But the US government accounts for less than 15% of Honeywell’s total revenue.

The automation and controls (A&C) unit, which generated 36% of the company’s net income in 2010, sells a wide range of products to manufacturers and other industrial outfits.

The first quarter was also kind to A&C, with sales jumping 17% from a year ago. Customers in both developed and emerging markets continue to spend on upgrades that promote conservation and energy efficiency, a traditional strength for Honeywell.

Although the firm’s specialty-materials division accounted for only 11% of 2010 net income, the unit posted a standout first quarter, during which sales soared 19% from a year ago and profit margins hit a record high.

The company’s UOP subsidiary shows particular promise. Refiners rely on the outfit’s advanced catalysts to refine lower-quality oil, an important capability; heavy and sour grades of crude offer the best profit margins.

With its early-cycle businesses firing on all cylinders, and demand for its late-cycle products picking up, Honeywell’s growth prospects are bright. Buy it up to $70. [Shares traded just above $60 Monday—Editor.]

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