Bottom Line: Honeywell smells really good but….

Two years ago, Honeywell was facing a financial crisis, the type it had not faced in recent times. It reported a loss of N3 billion and was saddled with debts it struggled to repay as and when due. The year before it saw its profits decline by 66% to N1.1 billion. Honeywell had achieved steady growth in earnings growth over preceding three years before the 2015 blip. Incidentally, the Nigerian economy was in a tailspin and it was easy to pin the blame on the ensuing recession.

The 2016 loss of N3 billion was hard to chew as it depleted its retained earnings to N5.9 billion. Honeywell had to do something fast if it was to remain profitable and financially solvent. The last thing it needed was distractions bothering on its fundamentals, especially when it operated in a very competitive space. It quickly revalued its assets and gained about N32 billion in revaluation surplus. That was enough to give its balance sheet a semblance of strength and allow it face its two of the main challenges; Revenue growth and input cost.

Between 2015 and 2016 Honeywell’s Gross Profit Margins dropped to 15% and 8% respectively. This compared to the 18.8% it reported in 2014 when it posted an impressive profit after tax of N3.3 billion, the highest in the last 5 years. To return to its pre-2015 margins it will have to reign in on cost by increasing sales. Its most recent interim results suggest it has achieved this.

In its 2017 annual report, the company reported a gross profit margin of 23.8% as sales climbed 4.3% while the cost of sales dropped 12.9%. It also reduced operating expenses relying on the savings as a cushion for its ballooning interest cost. The same strategy has been followed in the current year as its 9 Months results released in December showed revenue rose 44% while gross margin was 23%. The spike in revenue filtered all the way to bottom line and pending its full-year result expected any time soon, earnings per share is currently at 35kobo. Consider the fact that, it was 17kobo this time last year.

Honeywell has two business segment, Apapa, and Ikeja and it seems its future is dependent on what happens in its Ikeja segment. Honeywell’s Apapa division oversees its more profitable arm, the flour business while the Ikeja division is where operations of its loss-making Pasta making business is located. Of the N11 billion in operating profit it reported last year, N10 billion alone came from Apapa. Currently, Ikeja is operating at a loss while Apapa again is leading the charge with N7 billion in operating profit.

While results from the Ikeja division is disturbing, the fact that it relies only on one-half of its business operations for all its profits indicates just how much potential the company has. The company expects its new factory in Ogun State to come on stream this year (earlier scheduled for 2018 Q1). The factory is projected to raise the total installed capacity of the company by 150% at its completion and will include 4 pasta lines with an installed capacity of 125,000 metric tonnes. Will this all translate to a better bottom line? Perhaps yes, but not in the short-term. The company will still need to rely on its Flour business for another year or two before it starts to reap the benefit of investing billions in a new factory.

For now, the improvement in the fundamentals of the company suggests the company may possess some upside for a potential rally. Trading at a price-earnings multiple of 4.55 to its trailing twelve months earnings per share, the stock appears cheap when compared to Flourmills Nigeria at 7.73 and Dangote Flour at 4.24x. It is also trading at a huge discount to its book value (0.36) all pointers to its potential upsides. Year to date the stock is up 17% and 49% off its year high of N3.7.

But there are concerns. The company is heavily indebted and still has a spat with Ecobank to resolve conclusively. Revenues, which it so needs to continue growing dropped drastically in the third quarter ending December 2017. There is palpable fear that this could continue into the fourth quarter.

If it is to reward shareholders with capital appreciation, then it will have to declare not less than 25 kobo in dividends when it eventually releases its results. Is that even possible? At 25 kobo it will have to shell out about N1.9 billion in cash. It has about N14 billion in cash though without factoring its existing loans. It also has a retained earnings of N12 billion (less N32 billion in Revaluation Surplus) to support this case.

Bottom Line

Honeywell smells good enough for a stock good but we are not sure if it tastes as good as it smells. Its much-anticipated 4th quarter results could leave a bad taste in the mouth of investors especially if it misses its revenue estimates and fails to reward shareholders with impressive dividends. However, the smell is good enough for me to consider placing an order.

Note: This is not a recommendation to buy sell or hold this stock. Please read our disclaimer policy. Ugodre does not own any shares in Honeywell Plc and does intend to buy any within 48 hours of writing this article.