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In-line performance; supply-chain concerns persist

Honeywell Automation India’s (HAIL) performance in Q2FY23 was in line with our estimates. Revenue increased 7.7% YoY and was flat QoQ at Rs7.9bn (ISECe Rs8.1bn). EBITDA increased 19% YoY to Rs1.3bn. EBITDA margin at 16.1%, which was ahead of our estimates, improved by 152bps YoY. This was led by 214bps improvement in gross margin. PAT was higher due to doubling of other income. Operating cashflow generation decreased 13% YoY to Rs1.47bn on account of higher working capital. With government’s ongoing push towards building a holistic infrastructure in the country, we see an increased traction towards automation across multiple industries. However, supply-chain issues, especially related to semiconductors, still persist and may take a few quarters to normalise. Factoring in higher gross margin and other income (cash balance of ~Rs20bn), we raise our FY23E/FY24E earnings by 9%/10%, respectively. Therefore, we upgrade our rating to REDUCE from Sell with a revised target price of Rs34,380 (previously: Rs31,212).

* Q2FY23 operating performance in line with estimates: Revenue in Q2FY23 grew 7.7% YoY / flat QoQ to Rs7.9bn, in line with our estimate of Rs8.1bn. EBITDA increased 19% YoY to Rs1.3bn. EBITDA margin at 16.1%, ahead of our estimates, improved by 152bps YoY. This was led by 214bps improvement in gross margin. Other income doubled to Rs449mn due to higher yield on healthy cash balance. Hence, PAT came in at Rs1.18bn (ISECE: Rs1bn), up 38.4% YoY.

* Industrial production revival to support process automation business: Apart from its core business in process industries, HAIL has been incrementally focusing on strengthening its metal, pharma, life sciences and gas businesses where it has synergy in product portfolio within the process automation business. Additionally, the company aims to diversify in the fast-growing renewable energy market.

* Increased capital outlay bodes well for building solutions business: The FY23 Union Budget had laid incremental focus on building a robust civil infrastructure in the country. HAIL, a major player in building automation solutions, provides automation and control technologies to core infrastructure segments such as airports, metro, railways, ports and large-scale data centres. It is poised to leverage the government’s increased capital outlay towards these segments.

* Upgrade to REDUCE: HAIL has longer-cycle orders compared to its peers ABB and SIEM. We expect revival in HAIL’s performance as near-term headwinds wane out. Long term secular growth drivers in process automation and digitisation, building management and cyber security, and constant improvement in product portfolio will drive HAIL’s long-term growth. We believe supply-chain issues, especially related to semiconductors, still persist and may take a few quarters to normalise.

Outlook and valuation

Honeywell Automation India (HAIL) is in a unique position as a secular play in the domestic process automation opportunity. It is also trying to hedge itself from the oil & gas industry by focusing on other areas such as building automation, ‘smart city’ solutions, cyber security, etc.

The three major focus areas in near term are: (i) Healthcare and pharma, (ii) air quality and hygiene products & solutions, and (iii) products and systems to facilitate remote working and connected buildings.

Due to improvement in margin in Q2FY23, we raise our FY23E and FY24E earnings by 9% and 10%, respectively. We assign a 60x P/E multiple to FY24E earnings and arrive at a revised target price of Rs34,380 (previously: Rs31,212). We upgrade our rating to REDUCE from Sell.

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