Honeywell Aerospace: an
industrial built for take-off

Honeywell Aerospace became an independent company in June this year following its separation from Honeywell International. While Honeywell has been involved in aviation for decades, its aerospace operations previously sat alongside businesses spanning automation, building technologies and advanced materials.

As a standalone company, Honeywell Aerospace is now focused exclusively on technologies used to operate aircraft. Investors can therefore gain direct exposure to an aerospace company generating around US$17 billion in annual revenue, rather than one division within a much broader industrial conglomerate. The separation should also make it easier to assess the company’s performance, capital requirements and long-term prospects on its own merits.

Supplying critical systems

Honeywell Aerospace doesn’t manufacture aircraft. Instead, it supplies many of the critical systems that enable them to operate safely and efficiently. Its equipment is installed on around 90% of aircraft currently in service worldwide.

The company operates across three main divisions:

• Electronic Solutions provides cockpit systems and avionics, including navigation, communication and sensing equipment.
• Engines and Power Systems supplies aircraft engines and auxiliary power units (APUs). An APU is a smaller engine, typically located in the tail of the aircraft, that provides electricity, air conditioning and other essential services when the main engines are not running, such as while the aircraft is parked at the gate.
• Control Systems supplies equipment that manages functions such as cabin temperature and pressure, braking, and the movement of aircraft control surfaces.

Although these products perform different functions, they share an important characteristic: they are essential to the safe and reliable operation of an aircraft. Once a Honeywell system has been designed, certified and installed on a particular aircraft model, it often remains in service for decades.

Why we like the industry

Our investment case starts with the aerospace industry itself. Over long periods, global air travel has grown at roughly one-and-a-half to two times the rate of the world economy. As incomes rise, more people gain access to air travel, while those who already fly tend to do so more frequently.

What makes the industry especially attractive is the aftermarket – the maintenance, repair, replacement parts and upgrades required to keep aircraft operating throughout their lives.

Supplying equipment for a new aircraft is often only the start of a much longer relationship. Commercial aircraft typically remain in service for decades and must be maintained to stringent safety standards throughout that time. Once Honeywell equipment has been designed into an aircraft and certified, replacing it with another supplier’s product can be costly, disruptive, and may require additional testing and certification.

The result is a large installed base that continues to generate revenue long after the original equipment has been sold. Aftermarket revenues are typically more profitable than original equipment sales and provide a more resilient source of demand across the aviation cycle.

Honeywell through our lens

When assessing industrial companies, we look for exposure to markets that can grow faster than gross domestic product (GDP), durable competitive advantages, products that are difficult for customers to replace, and management teams that allocate capital well through acquisitions and share buybacks. We then assess whether the valuation offers an appropriate return relative to the quality of the business and its long-term growth prospects.

Honeywell Aerospace scores well across the first four measures. Air travel provides the above-GDP growth opportunity, while stringent safety and certification requirements create high barriers to entry. Its products are deeply embedded in aircraft that can remain in service for 20 years or more, supporting recurring aftermarket revenue. We also have confidence in the management team, whose incentives are closely aligned with long-term shareholder value creation.

Valuation requires a more balanced assessment. Honeywell Aerospace is not a statistically cheap company, nor would we expect a business with its margins, returns on capital and aftermarket exposure to trade like an average industrial. Nevertheless, we believe the current share price appropriately reflects the investment and execution required over the next few years while still offering attractive long-term return potential.

This is central to our investment process. We are not simply looking for the cheapest companies, which are often inexpensive for good reason. Equally, we are unwilling to pay any price for a high-quality business. Our objective is to invest where business quality, long-term growth prospects and valuation align.

The bottom line

We invested in Honeywell Aerospace because we believe it is a high-quality company operating in an attractive industry with favourable long-term fundamentals. Its products are deeply embedded across the global aircraft fleet, its aftermarket revenues provide resilience, and its end markets have historically grown faster than the broader economy.

We do not expect growth to be perfectly linear over the next few years. Honeywell will need to invest in its supply chain and production capacity to support future demand, and the benefits of that spending are likely to emerge gradually. This could create periods when earnings growth doesn’t fully reflect the strength of the underlying business. We believe, however, that these challenges are well understood and appropriately reflected in the current share price.

As a newly independent company, Honeywell Aerospace also benefits from a more focused management team. Together with its competitive position, long customer relationships and exposure to the structural growth in air travel, this give us confidence that Honeywell Aerospace can compound shareholder value over many years.