Better buy: GE vs. Honeywell

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There is no absolute in investing. There is no risk without reward, and no reward without risk.

Platitudes? Probably, but they help frame the buying discussion General Electric (NYSE: GE) versus Honeywell International (NASDAQ: HON) Stock. GE represents the risky / higher reward option while Honeywell is the risky / lower reward option. But overall, what’s the best buy?

Comparison of valuations between Honeywell and General Electric

General Electric is a recovery coin that has more upside potential if all goes according to plan and commercial aerospace markets recover on time. Meanwhile, Honeywell is certainly the higher quality company with more secure revenue streams, but it is trading on a high valuation, which limits the upside potential of its shares.

These arguments can be expressed by looking at the Wall Street analyst consensus for free cash flow (FCF) generation for the two companies and what that means for their valuations. Typically, a FCF futures price multiple of around 20 is considered a decent value for an industrial conglomerate.

Image source: Getty Images.

The table below allows two conclusions to be drawn. First, neither of the two stocks seems to be of great value at the moment. Anyone buying either stock will need to be patient and / or believe that there is potential for upward earnings and growth in the FCF.

Second, GE’s FCF is expected to improve dramatically in the coming years while Honeywell is expected to return to 2019 levels in 2022. Based on that, you could argue that GE is the best value, because based on the estimates of analysts, its valuation will be lower in 2022 and should have better growth momentum. Case closed?

Company / Metric

2019

2020 East

2021 East

2022 East

Honeywell FCF

$ 6.1 billion

$ 4.3 billion

$ 5.4 billion

$ 6 billion

General Electric FCF

$ 2.4 billion

($ 1.2 billion)

$ 2.8 billion

4.6 billion dollars

Honeywell price in FCF

24.2 times

33.8 times

27.4 times

24.4 times

General Electric price in FCF

42.6 times

N / A

36.6 times

22.3 times

Data source: marketscreener.com, author’s analysis using current market capitalization through 2022.

The case of General Electric

Unfortunately, investing is not that easy. There are the numbers and then there is believing in the numbers. As such, investors should never slavishly follow the Wall Street consensus and always consider the risk of falling numbers. Investors should also consider the upside risk.

The arguments in favor of the takeover of General Electric are based on the idea that the commercial aviation markets will recover, leading to improved sales of engines and spare parts, while military aviation sales will provide some support. Meanwhile, investors are hoping that the electricity and renewable energy margin will be improved online with GE peers. Continued growth in healthcare is expected to provide support for earnings and the FCF during the recovery period.

General Electric industrial segment

First nine months 2020

First nine months 2019

Switch

Power

($ 19 million)

($ 84 million)

(122.6%)

Renewable energy

($ 493 million)

($ 469 million)

5.1%

Aviation

$ 681 million

$ 4,764 million

(85.7%)

Health care

$ 2,212 million

$ 2,714 million

(18.5%)

Data source: General Electric.

The downside risk is that commercial aviation will not recover as expected, and there can be no assurance that in-house execution with the power and renewables segments will generate margin improvements as expected. The upside risk lies primarily in the ability of the management team to make operational improvements as planned; an argument that explains why CEO Larry Culp is a key part of the stock buyer’s case.

The case of Honeywell

Honeywell’s profits have held up much better than GE’s during the pandemic, and it has a much more diverse revenue stream to build on going forward. In fact, some of its companies are questionable beneficiaries of the pandemic. For example, its warehouse automation (primarily for e-commerce logistics) and its personal protective equipment business in the security and productivity solutions segment performed very well.

The relative overexposure of the aerospace segment to business aviation, a market much better than commercial aviation – helped Honeywell. In addition, a good exposure to defense and space (around 15% of the company’s total turnover in 2019 compared to 24% for commercial aviation) will also provide support.

Honeywell International Segments

First nine months 2020

First nine months 2019

Switch

Aerospace

$ 2,082 million

$ 2,653 million

(21.5%)

Honeywell Construction Technologies

$ 794 million

$ 868 million

(8.5%)

High-performance materials and technologies

$ 1,373 million

$ 1,790 million

(23.3%)

Safety and productivity solutions

$ 610 million

$ 598 million

2%

Data source: Honeywell International.

The main downside risk for Honeywell comes primarily from the overall risk to the economy and, to a lesser extent than GE, from conditions in the commercial aerospace market. On a positive note, Honeywell Building Technologies (HBT) may be able to drive sales growth through the sale of technologies aimed at creating healthier, cleaner buildings. In addition, if the price of oil continues its current rally, Honeywell’s processing solutions and UOPs (refining absorbents and catalysts) should have upside potential.

Jet airplanes flying.

The two companies hope for a resumption of air transport. Image source: Getty Images.

Better to buy?

Frankly, you don’t have to buy either stock – there are plenty of other investment options. That said, if I’m forced to choose, I think GE is a slightly better buy right now.

Honeywell is the premium company and if you were to buy and hold a company for the next five years you could say that there is a higher degree of certainty that you will generate positive returns with Honeywell. However, Honeywell’s upside potential is limited by its valuation, while GE still has some upside potential if its end markets and internal execution go as planned.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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