Honeywell Automation India Ltd (HAIL):

Honeywell Automation India Ltd (HAIL) is a subsidiary of Honeywell International, a leading technology innovator and manufacturing company. Today, the Honeywell group is the leading global provider of integrated automation and software solutions.

The Honeywell Group’s business is centered around 4 strategic business groups – Automation and Control Systems (ACS), Aerospace, Performance Materials and Technologies (PMT), and Transportation Systems (TS).

All four business groups are present in India; however, HAIL’s business is comprised of,

HAIL was started as a Joint Venture between Honeywell and Tata Group in 1987 and was listed on the domestic bourses in 1989. In 2005, Honeywell bought out Tata Group’s stake thereby making Honeywell Group its sole promoter.

Business Model:

HAIL’s business revolves around developing products that improve the security, safety, energy efficiency, and productivity of their customer’s processes.

Today, it operates entirely through a B2B model (a few years ago it did have a B2C component).

The Honeywell Group occupies a spot amongst the top 2 global players in each of their business segments described below.

Business Segments:

Honeywell Process Solutions (HPS)

Honeywell Building Solutions (HBS)

Environmental & Energy Solutions (E&ES)

Sensing & Productivity Solutions (S&PS)

Exports – Global Manufacturing (GM) & Global Engineering Services (GES)

HAIL doesn’t undertake any R&D activities at its entity level. Instead, Honeywell International undertakes all the R&D at the parent level and provides royalty free access to its subsidiaries. It is likely that Honeywell International does this at a parent level to ensure global economies of scale (spreading R&D costs indirectly across its many subsidiaries). Generally, MNC subsidiaries pay royalty fees to the parent, but in the case of HAIL this doesn’t hold true.

Competitive Advantages and Economic Moats enjoyed by HAIL:

Leverage Honeywell’s Market Leadership on a Global Scale – Economies of Scale & Brand

Honeywell International is a market leader across the strategic business units run by HAIL commanding either the first or second position globally.

Automation continues to evolve rapidly as it begins to encompass not only the hardware components, but the software components that bring the entire system together. Thus, competitors in the automation space now need to encompass the full value chain – hardware, software, and aftermarket services, which results in significantly higher innovation costs.

By virtue of its market leadership, Honeywell can spread these increasing R&D and innovation costs on significantly higher volumes, thereby enjoying global economies of scale for their R&D endeavors.

The ‘Honeywell’ brand enjoys recognition in the B2B channel and may allow the company to tie down deals quicker than newer smaller competitors. They also enjoy a B2C brand presence in some countries (Not Applicable for HAIL).

Royalty Free Access to New Technology

HAIL enjoys all the benefits of its parent’s status as a technology leader in the automation space without having to spend a dime.

Diverse User Base and End-to-End Servicing

HAIL caters to a user base that belongs to a diverse set of industries thereby protecting the company from cyclicality of some of its end user industries such as Oil & Gas, Petrochemicals etc.

HAIL is an end-to-end supplier – hardware, software, and aftermarket services. This ensures that even after the execution of a project, the company continues to earn service revenue on an annual basis. By handholding the customer through the entire process and by catering to the entire ecosystem of needs, the company ensures that it develops high customer switching costs.

Risks Faced by HAIL:

Deferral of Capex

HAIL’s business is driven by the capital expenditure needs of its customers. The deferral of said capex, generally in lean times, can lead to a slowdown in growth. Over the years, the company has addressed this issue by developing products that cater to the incremental capex needs of customers.

Over the years, HAIL’s exposure to capex heavy but cyclical Oil & Gas industry has reduced from over 60% of revenues to about 20% today.

Increasing reliance on Sales to Honeywell Entities

The Exports Revenue for HAIL majorly encompasses the sales made to Honeywell Entities globally. As can be seen from the chart, the export revenue has been increasing its share as a % of total revenue thanks to faster growth.

While many would see this with a negative perspective, I feel that being a subsidiary of an MNC which enjoys a highly productive low-cost manufacturing base, this would be a strategic move on the parent’s part.

Export business provides higher margins to HAIL, and hence, wealth that belongs to shareholders is probably not being siphoned away via subsidized rates which would otherwise result in lower margins.

2014-2015* – 15 Month Period, Export RPT – Exports to Related Parties (Honeywell Group)

Heavy reliance on Honeywell International for Product Development and R&D

HAIL relies entirely on its parent for technological support and new product development. Hence, in a way, HAIL’s success with its products is related to its parent’s R&D capabilities.

Sometimes, products need to be differentiated based on geography / demography etc, to be successful. When R&D is conducted at a global scale, it may lead to missing these key differentiators that lead to success.

However, since HAIL is working on developing products that are unique to the needs of India, it does show that region specific R&D and product development is being conducted, albeit at a global scale (enjoying economies of scale).

Slowdown in the Economy and Crude Oil Prices

A broader slowdown in the economy has a cascading effect on different sectors, especially, in the highly cyclical Oil & Gas and Petrochemical sectors. The construction and residential building sectors (rising inventory) also take heavy hits when a slowdown occurs.

Although low crude oil prices are beneficial for the domestic economy (and hence for the domestic business), they are bad for the exports business since some of the customers belong to the Oil & Gas sector in the Middle East and North America.

Competition

Honeywell International is well poised amongst its competitors thanks to its differentiated products and market leadership position.

Its key competitors include Carrier Global, Johnson Controls, Schneider Electric, Siemens, 3M, Kion Group, and MSA Safety Incorporated.

Opportunities:

The need for automation has been widely recognized by industries over the past few years. I have already covered business segment growth drivers under the business model section.

Financials:

HAIL has enjoyed improving performance metrics over the past few years due to,

2014-2015* – 15 Month Period

HAIL’s After Tax ROIC has surged in recent years due to a burgeoning Cash & Cash Equivalents balance of INR 1570.53 Crs. The company says that it requires the cash to,

2014-2015* – 15 Month Period

While going through the company’s reports, I came across two expense line items which seemed to be unjustifiably high. I was unable to find any explanations for the same.

When compared to the Employee Benefits Expense, the Travelling & Conveyance expense seems to be absurdly high.

The Corporate Overhead Allocations could be a line item where certain costs incurred by the parent (setting policies and procedures for the subsidiaries, reporting consolidated results, engaging in M&A deals) are dumped onto HAIL.

While these expenses do dampen the profitability of HAIL, do remember that HAIL does not pay any royalty to Honeywell International. Hence, this could be some form of an arrangement where the parent shifts some expense onto the subsidiary instead of receiving royalty fees.

In a recent development, Honeywell International has decided to delist from the NYSE and move to the NASDAQ – a move that it hopes will bolster its image as an industrial automation-based software company (it is working on releasing SaaS platforms for its customers, this will ensure higher recurring revenue) and thereby command higher valuations from the market (software firms enjoy higher valuations than industrial firms).

Valuation:

I feel that HAIL is in a commanding position to take advantage of the increasing adoption of automation and allied processes across infrastructure and manufacturing facilities. I expect the company to clock a revenue growth CAGR of 7.6% over the next decade whilst largely maintaining its margins between 17% – 20.5%.

A terminal year growth rate of 4.05% is assumed along with stable margins at 17%. ROIC is held at 11.67% in the terminal year.

Based on my understanding, Honeywell Automation India’s intrinsic value is INR 11,789.52 per share (Intrinsic value band is INR 11,022.96 to INR 12,172.8).

Holding all other metrics constant whilst changing the expected revenue growth rate, we get valuations of,

10 Yr Revenue Growth CAGRHoneywell Automation India’s Intrinsic Value Per share
7.6% (My Base Narrative)INR 11,789.52
8.5%INR 12,500.45
10.5%INR 13,914.11
12.5%INR 15,793.13
15%INR 18,518.22

Hence, on an intrinsic value basis, the company is overvalued when compared to its current market price of INR 42,499 per share.

Conclusion:

Honeywell Automation India occupies a leading position in the automation market and continues to thrive due to its strong relationship with Honeywell International.

The company has witnessed a significant and sustained re-rating over the past 10 years thanks to improvement in working capital management and margins, with its PE ratio band moving from 18-20 to around 55-80. This re-rating has come about despite a lackluster annual topline growth rate of just 11%.

HAIL enjoys a premium valuation due to; its leadership status, being a branded MNC, and having an extremely low float of just 22 lakh shares available to the public!

To put things into perspective, the company commands valuations that are observed in the FMCG space (Nestle India, Hindustan Unilever etc).

There is a large disconnect between the market’s valuation and my intrinsic valuation (you will observe this when you value a company like Nestle India or Hindustan Unilever too!), but this does not bother me at all! I do like the business, but personally, I cannot wrap my head around the current price of INR 42,499 per share!

In case you wish to read about MNCs / Foreign Promoter held companies, here are a few of my articles,

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