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FOOL PLATE SPECIAL: An Investment Opinion
Honeywell to Jettison Consumer Group

As Honeywell moves to tighten its business focus, investors are expecting slower free cash flow growth. Problem is, when a company is in the midst of repositioning itself, it's very hard to predict future free cash flow. You can see what kind of growth the market expects, but that's about it

By Richard McCaffery (TMF Gibson)
August 25, 2000

Last night, industrial conglomerate Honeywell (NYSE: HON) said it hired an investment bank to help sell its $1.1 billion consumer products group, which makes brand name automotive products such as Prestone antifreeze and Fram oil filters.

The move isn't a big surprise for Honeywell investors. The company warned in July that earnings this year and next will be lower than expected, and announced it will lay off workers, cut costs, and look for divestments to improve operations. Not counting the effects of acquisitions, divestitures, and foreign exchange, sales in the second quarter fell 1%.

The consumer products group, home to 4,400 employees, isn't a focal part of the company's $24 billion operation, which is driven by sales of aerospace, automation, and control products.

Cash flow woes
Most troubling about slower earnings growth is that it was accompanied in the second quarter by a reduction in operating cash flow. At the end of the second quarter, cash flow from operations fell to $898 million from $998 million a year ago, and free cash flow fell to $483 million from $568 million a year ago.

Still, a closer look at cash flows indicates that some of the reductions are arguably due to onetime items, such as a $356 million tax bill on the sale of businesses and investments. It's not clear to me why cash flow won't start to accelerate again over time, though clearly the company needs to get sales moving.

Slower growth priced into shares
Sometimes it can be useful running a discounted cash flow analysis on a company's profits to get a feel for what kind of growth the market is expecting. In January, after reporting 1999 free cash flow of about $2.10 per share, Honeywell's stock traded at about $53. This implies that the market expected Honeywell to grow its free cash flow about 16% per year discounted at 12% for risk. Last year the company increased its free cash flow an impressive 21%.

Things have changed since the Q2 warning. For starters, through the first half of the year Honeywell has generated 15% less free cash flow, which puts it on pace to produce about $1.4 billion in free cash flow for the year, or $1.79 per share. At its current price, Honeywell is expected to grow its free cash flow at about 15% annually, discounted at the same 12% rate.

This back-of-the-envelope number-crunching isn't scientific, but investors should ask themselves if that kind of growth is reasonable to expect. In my opinion, with the continued sale of business units and merger-related and repositioning charges, it's very hard to get a good sense of it.

Your Turn:
Is it reasonable to expect Honeywell to grow its free cash flow 15% annually? Post your thoughts on the Honeywell discussion board.

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