Honeywell International Inc.'s (NYSE: HON) future China growth should outperform, even China's overall pace of economic expansion were to slow further.
China's slower pace of economic expansion (over the past 1-2 years) may ultimately not revert toward a re-acceleration the way many aspire. However, the growth across dozens of tier 2, 3 and 4 cities (1 million persons plus) should provide significantly faster growth opportunities than the overall market as these centers industrialize while economic expansion broadens throughout the country.
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"Significant business opportunities could ensue, such as more rapid growth of Honeywell's Life Safety respirator masks and building air and water filtration solutions – Honeywell filtration solution content in an "average" sized commercial building in China is roughly $5mm," Deutsche Bank analyst John Inch wrote in a note to clients.
U.S. MNCs have substantially ramped Chinese R&D by over 20x over the past 15 years, according to the American Chamber of Commerce in Shanghai. Chinese companies have been increasingly aligning with U.S. multi-national corporations.
Honeywell's future China (non-Aerospace, principally ACS/Turbo) growth will be derived from tier 2+ cities. The company is anticipating adding roughly 85 percent of new headcount in these cities over the next 5 years that will account for about 60 percent of the company's workforce in China.
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Meanwhile, aerospace growth in China in the near term is expected to be slow – particularly aftermarket – as central government cutbacks specifically reduce business-class air travel demand, resulting in spare de-stocking among Chinese airlines.
"Se! gment growth is expected to be flat this year, down from 13-15% growth last year. Spare/R&O revenues represent the high majority of Honeywell Chinese Aerospace profit. Overall, high Chinese aerospace infrastructure expansion appears to remain on track," Inch noted.
Honeywell technology (eg, Ground Based Augmentation System or GBAS) continues to distinguish the company in terms of electronics aerospace-industry product development. This quarter, HON faces tough China Aerospace comparisons because of pre-buying a year ago.
The company anticipates the proliferation of Maintenance Service Agreements (MSAs) to drive future regional segment expansion. Long term segment growth to be driven by Chinese flight hour expansion – prospectively high single digits.
"Turbocharger growth in China appears on track for sustainable double-digit growth in future years – Honeywell is the leading global turbocharger player in China along with BorgWarner. Chinese regulation to drive 40% higher fuel economy requirements to approximately 5 liters/100KM by 2020," Inch said.
Honeywell expects industry sales to at least double to 10 million units by 2018 and the company is expected to outgrow the market and is currently in the process of increasing Chinese volume capacity by 2.5x. Honeywell is launching on 13 new vehicle platforms over the next 18 months.
Meanwhile, Honeywell's Process Solutions (HPS) launch of mid-range "PlantCruise" product about15 months ago, having taken only 9 months to develop, and reportedly meeting high success – accounting for 1/3rd of 150 in-country projects currently underway. Total China process market (for Honeywell served market) approaching $3 billion.
Honeywell shares leading position with competitors Emerson and Yokogawa, among other industry players. HPS sales mix roughly 80 percent installation and 20 percent service (service growing at 2x installation growth).
"In our view, Honeywell has developed substantially greater (localized) critical mass! over the! past few years, both within the key China market and across high growth regions globally," Inch added.
With its leading positions across all segments, the company could benefit from up to a point of annual margin improvement from internal initiatives before the contribution benefit of future volume increases.