2 for Tuesday: Honeywell's Leader Sweetens the Stock

Just like everybody else on July 3, Larry Bossidy should've been thinking about how to spend the July Fourth holiday. After all, he was supposed to be retired as the chairman of Honeywell (HON). Maybe he'd get in a round of golf with his former colleague, Jack Welch, the then-chairman of General Electric (GE).

But no, Bossidy was back in the hot seat that fateful day. The European Commission called off Honeywell's merger with GE. It's been speculated that Honeywell's board, disillusioned with Chairman and CEO Michael Bonsignore's handling of what should've been a marriage made in heaven, convinced him to step down. There was nothing else to do but ask Bossidy to return as chairman.

Within just 90 days of retaking the reins of the industrial conglomerate he'd helped assemble in the fall of 1999 with the merger of AlliedSignal and Honeywell, Bossidy had a plan. He stood up before the investment community Sept. 24 at the Pierre Hotel and put on a performance that was classic Bossidy: lots of slides with tons of detail, including cost-cutting goals, earnings targets and plenty of words like productivity, accountability and, of course, Six Sigma -- a philosophy of doing business that focuses on eliminating defects. It was gospel according to Bossidy and, to a certain extent, his golfing buddy Jack Welch. (What do you think they talk about for 18 holes?)

Emerging From the Merger Mess

Honeywell stock has enjoyed a nice bounce since hitting an intraday low of $22.15 Sept. 21. Clearly, the easy money has already been made. But if Bossidy can pull off the plan he laid out for investors, the stock is going higher. As one analyst friend of mine says, "He's not one to put up numbers and not make them." I agree. Having done well by Bossidy in the past, I'm willing to give him the benefit of the doubt. Even at $28, or 13.2 times expected 2002 earnings, Honeywell is worth a look.

Sweet Possibilities? Easy money has been made on Honeywell, but better times could lie ahead

Honeywell was -- and to a certain extent still is -- a big mess. Its attempted merger with GE was a major distraction, literally paralyzing the company at all levels. As a result, the integration of Honeywell and AlliedSignal stalled. The organizational structure became unwieldy; goals and accountability were unclear at best. Then the economy slowed, disaster struck, and a nascent aerospace cyclical downturn accelerated. Honeywell is going to have one of its worst years ever. When third-quarter earnings come out, just close your eyes. It'll be ugly. Honeywell is taking a huge $1 billion restructuring charge, and earnings will be down 40% at least.

But that's history. What you're buying here is a call option on Bossidy's plan. He's reintroducing the culture of productivity and accountability that had been largely abandoned in his absence. Savings from layoffs, plant closures and a more streamlined organizational structure, among other things, should produce cost savings of at least $1 billion next year. Bossidy told analysts that he and his team have accomplished more in 90 days than ever in the company's history.

Those savings, he hopes, will more than offset the effects of a tough economic environment. After all, Honeywell's businesses are cyclical, including specialty materials (chemicals for carpeting and refrigeration, for example), industrial automation (software and devices used to run plants, as well as thermostats for the home) and transportation products (a mixed bag of good businesses like turbochargers and lousy businesses like truck brakes).

Bossidy put up one slide that showed that the chemicals business would barely break even this year -- its worst year ever. Some of these businesses won't be around much longer, though. Bossidy is aiming to sell businesses that have a combined total of $2.5 billion in sales and to establish joint ventures for others to get better economies of scale. Proceeds from the sales could be $1 billion to $1.5 billion, which Bossidy says he'll use for stock buybacks.

The Aerospace Factor

What you need to worry about most here is aerospace, which is Honeywell's most profitable business and accounts for about $10 billion in sales, or 40% of the total, and an even greater percentage of earnings. For obvious reasons, this is taking a big hit: Operating profits are likely to be down 15% to 20% this year and another 7% in 2002.

But soon Wall Street will start focusing on an aerospace recovery and Honeywell's earnings potential beyond 2002. Coming out of the trough, Honeywell's aerospace solutions will be a terrific business and better positioned in terms of growth, cost structure and profit potential than before. Remember, this is what GE had its eye on and what the EU had the most problems with.

One of the real jewels in aerospace is avionics, or electronic systems used in aviation. There are tremendous applications for these products in everything from air traffic control and airport security to airplane safety, like the Enhanced Ground Proximity Warning Systems, which can alert ground control when aircraft divert from their flight paths, and products that can transmit cockpit voice recorder data automatically to the ground during emergencies.

Bossidy says his plan should result in $2.12 in earnings per share for 2002, up slightly from $2 a share this year. He assumes that the economic downturn will wipe out all but about $150 million of the $1 billion in cost savings. I'd say that's probably a realistic, if not conservative estimate. Bossidy wouldn't give precise cash-flow guidance yet, but at the moment he's looking at $800 million to $1 billion in free cash flow in 2002 -- not bad for a first swipe. Again, a price-to-earnings ratio of 13 on arguably "trough" per-share earnings of $2.12 is a pretty good valuation for a high-quality, diversified industrial company with market-leading positions.

The one issue Bossidy left unresolved is what happens July 1, 2002, when he's scheduled to end his second reign. A succession plan apparently isn't a current priority, but it will eventually become an issue. In the meantime, sit back and watch Bossidy in action. He'll be back in front of the investment community in December with a progress report. Stay tuned.

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