Analysis: Honeywell Automation India Ltd

Modified: 11-Sep-20

The current section of the “Analysis” series covers Honeywell Automation India Ltd, a part of Honeywell group, USA, is its Indian subsidiary working in automation and control systems in industries, buildings, automobiles etc.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

 

Honeywell Automation India Ltd Research Report by Reader

 

Dear Vijay Sir,

I have been an ardent follower of you for many years now. I have really learnt a lot from everything you write (your website), speak (podcasts) and share (your bike journeys).

I have tried to evolve with some basic framework to read businesses as per your guidance. In the same context would like to share my analysis on one of the companies Honeywell Automation India Ltd (HAIL).

I would really appreciate if I could get some views from you on the same.

Regards,

Sunny Bhardwaj

 

Financial analysis of Honeywell Automation India Ltd:

i) Sales growth:

Stable revenue trajectory with normal and consistent rates of growth across all buckets. Sales down in 2016 by almost 10%.

 

ii) Operating profit margin (OPM):

Consistent OPM in last 6 years but there was a substantial fall in margins from 2009 to 2010 and henceforth up until 2013. Need to investigate the reasons for the same. However, in brackets, it looks consistent. Need to analyze why margins dipped 2010- 2013 and the reasons/chances of the same recurring.

As per the annual report (AR) of 2010 (margins from 16% to 11%) of the company, the main reasons for OPM dip are as below:

  • Lower services buss. growth which is margin assertive by 4%
  • higher process and solutions growth by 28%, which needed a greenfield installed base investment that impacted margins in the near term like oil and refinery projects, PoC and setups but will bring long term benefits to the company. Basically, framework development costs which can scale up later
  • recessionary pressure continues with high competitive intensity
  • 14% employee cost increase over 6% headcount increase. The inflation-adjusted wage increase to retain talent (inefficient management)
  • Increase in international expenses passed on by parent to its global subsidiaries (royalty paid out is US$)

2011 AR (Margins from 11% to 9%)

  • Some of the major wins were ITC Hotel, Formula1 racing track, ESIC hospitals etc.
  • During the year, there have been significant new business opportunities (NBOs), which resulted in major wins with customers like Mahindra and Mahindra, Kirloskar Oil Engines etc.
  • There was something, which the management was not doing right. Back to back two years of Revenue growth of around mid-teens and still, the margins are getting lower, employee costs keep on increasing in mid-twenties with billing rates going lower and lower/ provisions keep on increasing (80%). The assets were not used optimally.
  • Billing rates keep on falling despite an increase in export and domestic revenues owing to competitive pressure and that too the reduction for selling to the parent entity. Something was not moving right.
  • Salaries increase by 20% for a drastic fall in OPM and CFO.
  • Travelling forming approx. 25% of Employees expenses

2012 AR (Margins dip further from 9% to 7%):

  • It empirically seems that the HAIL was rather coerced to lower their margins and billing rates in order to maintain their revenue opportunities sources by Honeywell Parent Holding Company. Therefore, they were being milked by the parent.
  • They were winning big projects, growing revenues but at the cost of margins, I mean margins literally more than halved from 16% in 2009 to 7% in 2012.
  • We now definitely need to look what happened in 2009 (OPM at 16%): So, what was so well in 2009 turned up so sour up until 2013 indicating that the business is highly cyclical and the management was not able to steer and guide the business properly under the circumstances.

2015 AR:

  • Management change: Anant Maheshwari made Director and Vikas Chadha came in as the Managing Director. Changes start happening.
  • This is the time when with Management change the focus was brought onto GM and GS with an aim of innovating and rolling out solutions globally from just being an enabler and cheap service provider. The credit cycles were tightened across and the focus shifted to Cash Flows and better WC mgmt. with employee expenses and productivity being started to managed better.

2016 (First year when even after a dip in revenues by 10% the Margins started to increase by 1%)

  • Since 2016, there was no mention of corporate allocations in the AR, which is as no more royalties were paid to parent holding company henceforth.

2017 (Both Sales and Margins Start Growing):

  • Board Changes. Mr. Maheshwari completely out and Mr. Vikas becomes the director and Mr Gaikwad becomes the new MD. Major overhaul of the board with the incoming of new CEO with an important vision for India (HAIL)
  • Exports increase to other subsidiaries
  • So, since thereof the company showed significant tighter WC management, better Margins, better FCF management. It seems that it was the change of the management at both domestic and holding company level, which brought the fortunes good for HAIL. The company witnessed better focus, better utilization, tighter control and discipline that changed the fortunes of the company since 2015. We need to keep a watch on the changing management context of the company and any deterioration in its working context ratios. We need to ensure the process are well set in place to take care of the company even in terms of future management changes.

 

iii) Tax & CSR compliance:

Fully tax compliant and with the future lowering of taxes to 25.17% from 31% will lead to a direct 6% EPS jump.

 

iv) Interest and depreciation absorption:

No debt and hence negligible Interest Cost and reducing depreciation costs very minuscule to Sales and very small to PAT. The company can easily absorb and return the benefits to the business in terms of reinvestment and dividends.

 

v) Debt and cash (CFO/FCF) profile:

Zero debt throughout its operations over the last decade and significant cash-rich Position with an FCF of 1174 Cr. Out of which 141 Cr. Has been paid as the dividend. Total Dividend to FCF => 141/1174 = 12%.

The company did a remarkable job in increasing its sales from 1175 Cr. in 2009 to 3396 Cr. in 2020 with nil debt. The sales have grown 3X in 10 years and the entire capex is 153 Cr. It has been managed through internal accruals only.

The company has a positive operating cash flow (OCF) in 8 out of last 10 years and especially all positive in last 6 years with OCF increasing remarkably by almost 100% (166Cr. -309 Cr.) in last 5 years (14.5 % CAGR).

More interestingly, the company works on a negative working capital cycle. i.e. it takes money from stakeholders (suppliers/vendors, customers) combined to earn cash without spending a dime from its coffer, indeed it always is cash surplus within the WC itself to generate profits. In FY 2018, its WC cycle (cash conversion cycle) was -92 Cr and in 2019, it was -198 Cr, which means it was still left with 92 Cr and 198 Cr. In these years of free cash from within, its working capital after the generation of profits was at 16% and 19% of OPM.

This essentially means that the company is in commanding power with its suppliers (payables exceed receivables)/ can negotiate on longer payables cycles, has good collection efficiencies from customers (demanding and critical product) without giving them extensive credits and can thus grow without any external debt or equity dilution over the long term. We would like to collaborate with these businesses for a long time.

 

vi) Capital returns (ROCE and ROE) profile:

Remarkable ROCE and ROE of high teens considering the amount of cash surplus the company is carrying on its books

Both the ROCE and ROE are in a consistently increasing trend over the years. Now with a 16% average ROCE (last 5 years) & increasing and zero cost of capital (cash surplus situation), the whole profits of the company belong to the stakeholders. It is a cash guzzling machine.

 

vii) Working capital cycle management

Being an industrial business with significant exposure to subsidiaries and foreign entities, the receivables to the sales amount to around 20% of sales on average. Nevertheless, there are encouraging signs of it decreasing recently. The company has been able to improve its inventories significantly though from a high of 7% to 11% to around 3 to 4% of Sales currently reflecting improvement in WC metrics.

We need to be still lookout for high rates of receivables to Sales and seek clarification from management on the same.

Overall, the NFA for the company has stayed same through the decade with very low CWIP indicating it has developed some sort of IP technology/process/ knowledge sharing from parent entity that it can generate higher revenues around 3X with a minimal increase in fixed assets. It is a very desirable situation when a business can continuously churn free cash flows from internal accruals without a significant capex to increase the NFA base.

Clearly, we can see that the company increased its sales from 1175 Cr. (2009) to 3396 Cr. (2020) with nearly the same amount of NFA and a very low capex of just 153 Cr. Such business held over long hauls can really generate a good-compounded growth.

No doubt that the NFAT has grown significantly for the business over the decade showing efficient asset sweating capabilities of the management

If we also look at the trends in buckets, we can clearly see that the company has been able to manage its receivables and inventories better v/s it revenue increase broadly.

If we look at the cost metrics, we can see that over the decade the company has been able to keep the various costs under check and rationalize the same with scale thus producing scale efficiencies and improving margins.

 

Management analysis of Honeywell Automation India Ltd:

The company has not diluted the equity base over last decade; with a consistent promoter holding of 75% and seems to have impeccable dividend payout record and the best part is that the dividend is not paid out of debt but free Cash flow accruals.

The dividend payout has been consistently increasing from 7% to 11% currently. The company seems to be building Cash for some future opportunity as it can very easily increase the payout owing its free cash flows and the major beneficiaries would be promoters/parent company as they own a healthy stake (75%) but it seems they are keeping the cash with the business. If they can deploy it at a ROCE of 18% + with zero cost of capital and keep the business growing it is fine, but for a prolonged no/slow growth phase it would be prudent to distribute the benefits to shareholders. This could also trigger a re-rating in future in case it happens.

For a 4X BV change and a 3.5X EPS change over the last decade, the market capitalization has increased by almost 9 times.

 

Efficient asset sweating:

Now, if your sales grow by 19% & with even 1% employee addition your employee costs stay the same % to sales means you are rewarding your employees better, sharing with them the commensurate incremental profits which are positive and encouraging signs for reducing employee attrition.

 

Focus areas in future for Honeywell Automation India Ltd:

  • Petrochemicals: Process Automation
  • Pharmaceuticals: Process Automation
  • 100 Smart Cities: Building Solutions
  • Electricity/Water/Gas Distribution: Process Automation
  • Railways Modernization/ Metros/Airports (new and upgrade)
  • Asset and Fleet Management Systems: Logistics
  • Products for Mass Mid- Market: B2C perspective

Please provide your inputs.

Regards,

Sunny Bhardwaj

 

Dr Vijay Malik’s Response

 

Hi Sunny,

Thanks for sharing the analysis of Honeywell Automation India Ltd with us! We appreciate the time & effort put in by you in the analysis.

Investors may note that initially, the company was set up as a joint venture between Honeywell and Tata group in 1987 as Tata Honeywell Ltd. In July 2004, Honeywell group acquired the stake of Tata group in the company and changed the name to Honeywell Automation India Ltd. At the same time, the company changed its reporting year from April-March to Jan-Dec. As a result, in 2004, the company reported only 9 months financials to align its reporting practices with the international Honeywell group, which follows Jan-Dec reporting year.

FY2004 annual report, page 8:

On 9 th July 2004, Tata’s and Honeywell announced their decision to end the joint venture of your Company by Honeywell Asia Pacific Inc. acquiring the entire stake of the Tata group,…….. name change of the Company from Tata Honeywell Limited to Honeywell Automation India Limited.

The Directors have taken the decision to change the financial year to end on 31 st December every year to be in line with Honeywell year ending.

The company followed the Jan-Dec reporting period until 2013 when it again changed its reporting period to April-March to comply with the provisions of the Companies Act 2013. As a result, in FY2015, the company reported financial results for a 15 months period (Jan. 2014 – March 2015).

FY2015 annual report, page 54:

Consequent to the change in the financial year of the Company from January – December to April – March with effect from the current year, the current year’s financial statements are for 15 months from January 1, 2014 to March 31, 2015. The previous year’s figures relate to the 12 months ended December 31, 2013

Therefore, an investor should keep this aspect in mind while she compares the financial performance of FY2015 with either FY2013 or FY2016. Thereafter, the company has continuously reported its results with April-March reporting period.

With this background, let us analyse the financial performance of the company since 2009.

Honeywell Automation India Ltd Financials FY2009 20

 

Financial and Business Analysis of Honeywell Automation India Ltd:

While analyzing the financials of Honeywell Automation India Ltd, an investor notices that the sales of the company are consistently growing at a pace of about 10% year on year from ₹1,175 cr in FY2009 to ₹3,290 cr in FY2020.

However, when an investor notices the operating profit margins (OPM) of the company over FY2009-2020, then she notices that the OPM of Honeywell Automation India Ltd declined from 16% in FY2009 to 7% in FY2012. Thereafter, the OPM of the company has increased consistently to 19% in FY2020.

Honeywell Automation India Ltd OPM FY2009 2020

While assessing the reasons for a sharp decline in the OPM during FY2009-2012, an investor needs to study the annual reports of the company to understand its business. An investor notices that the business of Honeywell Automation India Ltd comprises of many different business divisions. An investor needs to study each of these divisions is necessary to understand the factors influencing the business of Honeywell Automation India Ltd.

Let us try to understand the business divisions of the company.

 

i) Honeywell Process Solutions business (HPS):

As per the company, the HPS divisions provides automation solutions in the industries like emergency shutdown system and other self-controlling systems, which reduce the manual interventions in the processes.

FY2015 annual report, page 14:

HPS’ offerings include distributed control systems, field instruments, programmable logic controllers, emergency shutdown systems (ESD), quality controls systems (QCS), process and business performance improvement solutions and various value added services.

As per the company, HPS division serves some of the core infrastructure and manufacturing industries like oil & gas, power, chemicals, metals & mining etc.

FY2020 annual report, page 48:

We have the expertise and breadth of resources to execute projects of every size and complexity in the oil and gas, refining, pulp and paper, industrial power generation, chemicals and petrochemicals, biofuels, pharma/ life sciences, and metals, minerals and mining industries.

Therefore, an investor would notice that the business of HPS division of the company is primarily dependent on increasing automatic system controls in core infrastructure & manufacturing industries.

 

ii) Honeywell Building Solutions business (HBS):

The HBS business operates in commercial buildings and provides systems like access control (e.g. in offices), emergency response systems (e.g. fire control), security systems (e.g. CCTV) etc.

FY2020 annual report, page 48:

Building Solutions business provides automation and control technologies that help make buildings green, safe, and productive. As part of its intelligent buildings suite, it provides building management systems, fire detection and alarm systems, access control systems, video surveillance systems, integrated security systems, and integrated building management systems based on Honeywell’s Enterprise Buildings Integrator™

Therefore, an investor would appreciate that the HBS business unit depends primarily on the commercial real estate industry for its business.

 

iii) Building Management Systems business (BMS):

This business unit primarily works on automating the functioning of buildings, which operate as key locations of people’s movements like airports, metro stations, hotels, offices etc.

FY2020 annual report, page 48:

The solutions and products of this business are already present across multiple verticals in India, which include large mission-critical facilities, government infrastructure like airports, stadiums, metro stations, IT, residential, industrial and hospitality buildings.

Therefore, an investor would notice that the business of HBS unit is primarily dependent on the infrastructure sector (transportation) and commercial real estate.

 

iv) Sensing and Internet of Things (IOT):

Previously, this unit was known as Sensing and Control (S&C) unit. This unit primarily works on various sensors that provide inputs for controlling the units like an automobile, construction equipment, railway, any machine etc.

FY2020 annual report, page 48:

The Electronic Sensing portfolio which includes board mount Pressure Sensors, Airflow Sensors, Hall ICs, Temperature Sensors etc. helped the business to win in Medical, EVs segment.

This business unit is highly dependent on the automobile, construction equipment, military, aerospace and medical equipment sectors.

FY2015 annual report, page 15:

Your Company will continue to remain focused on verticals such as industrial, transportation, military, aerospace and healthcare.

Therefore, an investor would notice that the business of sensing & control unit is highly linked to the prospects of the automobile & transportation sector among others.

 

v) Global Services and Global Manufacturing business:

In this business, Honeywell Automation India Ltd primarily helps the overseas entities of Honeywell group in executing their contracts by either providing them services like project construction & management services or supply of electrical components

FY2020 annual report, page 49 (Global Services business):

It provides project engineering services, product customisation, and software development, driving productivity and cost competitiveness to several global Honeywell entities. This includes complete project management, systems design, engineering, sourcing, manufacturing, and testing undertaken at your Company’s Pune facility.

The Global Manufacturing business, Honeywell Automation India Ltd builds instruments, which are used primarily in its flagship process solutions business. The company has a manufacturing unit in Pune, which it uses to manufacture products used in Honeywell’s projects in India and aboard.

FY2013 annual report, page 11:

With Honeywell’s support and sponsorship, Pune became one of the four regional factories for Honeywell Process Solutions. This regional factory enables Pune to supply to the Middle East and Europe.

Therefore, an investor would notice that the Global Services and Global Manufacturing business is primarily a support business for Honeywell’s global and India operations where it provides manufacturing & project management services. From the business dynamics perspective, it depends on other Honeywell business units and the industries that determine the fate of other business units of Honeywell, in effect, determine the fate of Global Services and Global Manufacturing business as well.

From the above discussion on each of the business divisions of Honeywell Automation India Ltd, an investor would notice two things.

The first aspect that an investor would notice from the above discussion is that the business divisions of the company are dependent on core infrastructure, manufacturing, automobile, commercial real estate industries, which are highly influenced by the levels of general economic activity in the country. From one perspective, Honeywell Automation India Ltd seems like a company, which provides support services, value-enhancing proposition to the above-mentioned industries like oil & gas, commercial real estate, hospitality etc.

If these industries are not doing well, then Honeywell Automation India Ltd in itself may not be able to do anything to generate economic value. After all, to automate and add value to the functioning of a building, you need the construction of a commercial building. If the commercial real estate is going through a bad phase and there is no construction/up-gradation of commercial buildings, then the business of Honeywell Automation India Ltd is going to suffer.

In a similar fashion, the fate of Honeywell Automation India Ltd is linked to its various other customer industries, which primarily belong to the infrastructure, manufacturing, real estate etc. that, in turn, depend on the stage of the economic cycle of the country.

The company has continuously highlighted this dependence on the level of economic and investment activity in the country on its operations.

FY2019 annual report, page 46:

Your Company’s operating results are influenced by macro-economic trends such as industrial production, capital spending on process and building automation, commercial and infrastructure construction, commodity prices, and foreign exchange variations.

FY2007 annual report, page 13:

The growth in your Company’s business is dependent on the sustaining momentum of the economy – especially continued investments in infrastructure, manufacturing and construction.

In addition, the second aspect that the investor would notice from the above discussion on the features of different business divisions of the company is that most of the above industries like core infrastructure, oil & gas, power, commercial real estate, transportation etc. are project-based businesses. In such businesses, winning a project may not give a sustained growth opportunity and the company needs to keep winning orders for new projects to sustain its growth.

Read: How to do Business & Industry Analysis of a Company

During the period of FY2010-2012 when Honeywell Automation India Ltd faced a sharp decline in its operating profit margins from 16% in FY2009 to 7% in FY2012, then the company highlighted that the key reason for the decline was the tough business conditions faced by its consumer industries and the govt. spending on infrastructure.

FY2011 annual report, page 7:

Government spending is critical for development of core infrastructure like Roads, Ports, Airports, Mass Transportation Systems, Energy Conservation, Safety and Electronic Security Systems etc. Such spending supports volume growth of Buildings Solutions business group of your Company, and such spending has declined.

The project nature of company’s business affected its future as Honeywell Automation India Ltd highlighted that the projects are getting delayed and witnessing cost escalations.

FY2012 annual report, page 9:

the industrial and infrastructure sectors served by your Company saw significant slow-down during the year, which impacted both, new order inflow and also revenue recognition due to slow progress on existing backlog of long-cycle projects won in previous years. This was coupled with continued cost escalation on delayed projects.

While reading the history of Honeywell Automation India Ltd from FY2004 (the earliest available annual report on its website), an investor makes one more observation. An investor notices that during the global meltdown of FY2008-09, the company did not witness any business slowdown.

In FY2008, the company reported sales of ₹974 cr, an increase of 11% over the sales of ₹871 cr in FY2007. The company reported a net profit after tax (PAT) of ₹81 cr in FY2008, an increase of 24% over PAT of ₹65 cr in FY2007.

In FY2009, the sales of the company increased by 17% to ₹1,181 cr and its PAT increased by 62% to ₹132 cr.

From the above discussion on the project nature of its business, an investor may appreciate that during FY2008-2009, the company was executing the work on the projects won by it in previous years where the customers did not stop the construction/execution. However, the signs that new projects are not being announced by customers was evident in FY2009 itself.

FY2009 annual report, page 11:

Growth in volumes were driven by exports business which had an upcycle in large global project execution….. The proportion of Greenfield project revenue was, however, lower, due to purely cyclical reasons.

Therefore, it seems that the continued execution of previously announced projects of customers helped Honeywell Automation India Ltd report good financial performance during the height of global slowdown of FY2008-2009. Nevertheless, it seems that the new project announcements were down and even the previously announced projects that took a long time to complete were delayed by the customers.

As a result, it looks like Honeywell Automation India Ltd faced the impact of FY2008-2009 recession; however, it was not during the same period. It faced the impact in a delayed period when the existing good projects were finished and the long-drawn projects were delayed with cost escalations. In addition, the customers of the company delayed payments to Honeywell Automation India Ltd.

In FY2011 and FY2012, the company reported cash flow from operating activities (CFO) of negative ₹18 cr and negative ₹17 cr respectively. The company highlighted that the customers are delaying payments to it due to delays in the projects.

FY2012 annual report, page 11:

Pressure due to delayed payments from customers and increased working capital cycles for delayed projects. These were driven by tight money market conditions and a very challenging business and economic environment, which caused the Company to take higher charge on account of Provision for doubtful debts and Bad debt by 26% year on year.

FY2011 annual report, page 8:

During the year your Company was under severe pressure due to tight money market conditions and a very challenging business, economic environment, which caused the company to take higher charge on account of Liquidated Damages, Provision for Doubtful Debts and Bad Debt by 83% year on year.

From the above discussion, an investor may notice two things about the business of the company. First is that due to the nature of the company’s project-based business, the continued work on existing projects delays the impact of economic slowdown on its business. Second, as the company executes projects for many different industries, therefore, at times, the diversification helps it and the company does not face a severe hit on its business.

FY2020 annual report, page 50:

While your Company has diversified products and operates within varied industries, major macroeconomic developments pose some risks to growth which can have an impact on the performance. Diversification and strong industrial relations is helping manage these trends.

Moreover, the company seems to be one of the best in its job as the list of clients of the company includes many large corporates. In the past, the company could even win a contract to work on Rashtrapati Bhavan.

FY2012 annual report, page 10:

Major wins / customers include Bharti Airtel, Cognizant Technology Solutions, Delhi International Airport, IOCL, Kolkata Airport, Leighton Welspun, Reliance Industries, Tata Consultancy Services.

FY2004 annual report, page 9:

As a mark of recognition of our Performance Contracting business, a prestigious order was received from BEE (Bureau of Energy Efficiency, Government of India) for Rashtrapati Bhavan.

Therefore, an investor may appreciate that Honeywell Automation India Ltd does project-based work for many diverse industries, which to some extent help the company to mitigate the impact of the general economic slowdown. However, the economic slowdown does have an impact on the company’s business, which is usually apparent in a delayed period.

Honeywell Automation India Ltd is one of the best in its job of implementing automation & control systems. This helps it win prestigious large clients. However, it does not protect the company from the competition.

The company has highlighted that many of its competitors have developed technologies, which are put cost pressures on its products. As a result, the company had to reduce prices of its products leading to a decline in the margins.

FY2010 annual report, page 9:

..maturing engineering strategies of competition in low-cost geographies, particularly in the process automation space put margins under pressure

FY2011 annual report, page 8:

With prevailing economic and competitive scenario in rest of the world, GS are under tremendous pressure to meet productivity targets and meet competitive pricing. Your Company has reviewed the billing rates and consequently lower billing rates are agreed to with effect from January, 2012.

FY2010 annual report, page 8:

Net Income at Rs 105,05 Lakhs, down 21% over the corresponding previous period primarily due to an unfavourable revenue mix, competitive pressure on margins,

FY2012 annual report, page 11:

Competitive pressure on margins in the project and product businesses driven by lower selling prices as a result of the competitive market environment,

FY2012 annual report, page 9:

Overall geographic mix of global business is also shifting from North America and Western Europe earlier, to other countries in Asia, Middle-east, South America and Eastern Europe – these changes significantly reduce the cost benefit of sourcing services from India by Honeywell entities. Competitive pressures especially from developing nations in Eastern Europe and Central Asia are ever increasing with comparable options available to customers closer to their geographies.

Therefore, an investor would notice that despite being one of the best entities to do its job in the automation segment, Honeywell Automation India Ltd is not immune to competition and slowdown.

Read: How to do Business & Industry Analysis of a Company

A decline of operating profit margin from 16% in FY2009 to 7% in FY2012 is a significant event in the financial history of the company. Even though in recent times, the OPM has improved to 19%; nevertheless, an investor should study the FY2010-2012 period in detail to understand whether the current high-profit margins are immune to competitive challenges.

Investors should study FY2010-2012 period in depth to assess the susceptibility of the profit margins of Honeywell Automation India Ltd to future events.

While looking at the tax payout ratio of Honeywell Automation India Ltd., an investor notices that for until FY2013, the tax payout ratio of the company has been below the standard corporate tax rate prevalent in India. The tax payout ratio until FY2013 was in the range of 24%-30%. It seems that the lower tax rate was primarily due to the tax benefits available to it under Software Technology Parks of India and Special Economic Zone schemes.

FY2013 annual report, page 40:

Provision for taxation has been made after considering the various allowances / deductions available and after excluding profits derived from undertaking registered with Software Technology Parks of India under section 10A and unit registered under Special Economic Zone under Section 10AA of the Income Tax Act, 1961.

In FY2017, the tax payout ratio increased to 45%, about 10% more than the standard tax payout ratio primarily due to tax proceedings with authorities making the company provide a higher amount for taxes.

FY2017 annual report, page 98:

Additional tax provision for earlier years arising out of proceedings with the authorities during the current year: -9.47%

The tax payout ratio has declined in FY2020 primarily as the company has opted for the new corporate tax rate scheme.

FY2020 annual report, page 121:

The applicable Indian statutory tax rate for financial year ended March 31, 2020 is 25.17% and March 31, 2019 is 34.94%. During the year, the Company exercised the option available under section 115BAA of the Income Tax Act, 1961.

Further advised reading: How to do Financial Analysis of a Company

 

Operating Efficiency Analysis of Honeywell Automation India Ltd:

a) Net fixed asset turnover (NFAT) of Honeywell Automation India Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Honeywell Automation India Ltd in the past years (FY2009-20), then she notices that the NFAT of the company has consistently increased from 18 in FY2010 to 37 in FY2019. The NFAT has declined in FY2020 to 23; however, it is primarily due to change in accounting methods where the company had to include the office buildings taken on lease in its fixed assets.

FY2020 annual report, page 108:

Accordingly, as a lessee, the Company carried forward the historical classification of leases and recognized a ‘right-of-use asset’ and a corresponding ‘lease liability’ for its leasing arrangements on its balance sheet.

Therefore, an investor would notice that first, the NFAT of Honeywell Automation India Ltd is very high in the range of 20 or more and second the NFAT is further improving year on year.

An investor would notice that the high NFAT of 20 or more characterize primarily service businesses where the cost of the physical product delivered by the company may be very low than the value it provides. E.g. in a software sale, the cost of the CD may be minuscule when compared to the value of the software. In such companies, the main value is by the way of the intellectual capital added by the company. Therefore, the key determinant of value for such companies is the human capital and not fixed asset capital.

As a result, the investment in the fixed assets may not be the best determinants of the growth of the company. This is because the company can squeeze in more employees in the same building to generate additional business without incurring a high cost on fixed assets. Similarly, relatively small capital expenditure on a new building can add working space of many more employees who can lead to a significant increase in business than indicated by the investment amount in the building.

Therefore, in the case of companies like Honeywell Automation India Ltd where the major value addition to the customer is by way of intellectual capital, NFAT may not be the best parameter of the operating efficiency. Nevertheless, it can indicate to an investor that if the company has to grow its business in future, then it may not need a lot of capital investment in its assets because the business model of the company is very asset-light.

 

b) Inventory turnover ratio of Honeywell Automation India Ltd:

While analysing the inventory turnover ratio (ITR) of the company, an investor notices that the ITR of Honeywell Automation India Ltd has increased from 10 in FY2010 to about 30 in FY2020.

The company carries some inventory due to its manufacturing operations that produce instruments that are used in its automation and control system implementations across industrial units and buildings. However, from the above discussion, an investor would notice that the key value addition by the company is not the physical products but the intellectual capital that it brings to the customer. As a result, the company has been able to generate much higher sales than the value of the inventory on its books.

Read on: How to Assess Operating Efficiency of Companies

 

c) Analysis of receivables days of Honeywell Automation India Ltd:

While analysing the receivables days of the company, an investor notices that over the years, the receivables days of Honeywell Automation India Ltd have been continuously in the range of 70-80 days.

An investor would notice that the receivables collection period of 70-80 days is high when compared to the normal practice of an average of about 45 days prevalent across multiple industries.

From the above discussion on the business of Honeywell Automation India Ltd, an investor would notice that the primary nature of the work undertaken by the company is project-specific. In the project-oriented work, there are different milestones that determine when it would receive money from the customers.

In almost all the cases where the payments are linked to the achievement of milestones, we notice that the instances of disagreements between the customers and the suppliers related to proper achievements of milestones are very frequent. As a result, many times, the suppliers raise the bill; however, the customers keep on stressing for more work being done to their satisfaction before releasing payments. Therefore, the delay of payments in the normal course of business is very frequently seen.

This delay is in addition to the difficulties in realizing payments from the projects that are not doing well, the projects that have seen long delays due to difficulties in funding, wrong strategic direction, improper execution etc. In such delayed projects that witness time and cost overruns, the payments to all the suppliers are under problem. Many times, suppliers do not receive the payments for their work at all and it leads to bad debt i.e. non-recoverable receivables.

When an investor notices the breakup of the receivables of Honeywell Automation India Ltd, then she notices that almost all the time, a large portion of the company’s receivables are significantly delayed from the date they became due for payment by the customer.

The following table shows the details of receivables for Honeywell Automation India Ltd that are overdue for more than 90 days from the date they became payable by the customers. (Source: annual reports).

Honeywell Automation India Ltd Receivables FY2015 2020

An investor may note that the overdue of 90 days means that it is over and above the normal credit period given by Honeywell Automation India Ltd. So, if the company gives a normal time of 30 days for the payment to the customers when it raises a bill, then more than 90 days overdue means that the customer had not paid for more than 120 days (=30+90) from the day when the bill was raised.

From the above table, an investor would notice that Honeywell Automation India Ltd has consistently had a large portion of its receivables in the significant overdue segment.

From the above discussion on the business of the company, an investor would remember that during FY2010-2012, when the company faced tough times, then it has highlighted that the company was under server pressure, as the customers did not make payments on time.

FY2010 annual report, page 10:

Cash flow from operations was Rs. 45,63 lakhs, a decrease of 71% primarily due to large infrastructure projects having extended cash milestones and constrained credit markets in the overall commercial construction space resulted in increased working capital.

FY2012 annual report, page 11:

Pressure due to delayed payments from customers and increased working capital cycles for delayed projects. These were driven by tight money market conditions and a very challenging business and economic environment, which caused the Company to take higher charge on account of Provision for doubtful debts and Bad debt by 26% year on year.

As a result, in FY2011 and FY2012, the company reported cash flow from operating activities (CFO) of negative ₹18 cr and negative ₹17 cr respectively.

FY2013 annual report, page 11:

Tight money market conditions, as witnessed in some delayed payments from customers, caused your Company to take higher charge on account of provision for doubtful debts and bad debts.

Whenever an investor notices that a company has its receivables overdue for a long time, then it is natural that the investor would fear that the customer may not pay these receivables ever as the customer may dispute the billing in terms of rates/prices or achievement of milestones etc. In such instances, the company would not be able to collect the receivables and would report bad debt/non-recoverable receivables.

The following table shows that over FY2009-2020, Honeywell Automation India Ltd has acknowledged that it would not be able to recover receivables for more than ₹100 cr (source: annual reports).

Honeywell Automation India Ltd Receivables Written Off During FY2009 2020

An investor would notice that when a company faces challenges in collecting its dues from the customers on time and faces large overdue, then it would face money continuously being stuck in its working capital. This is because; the company ends up funding its customers by way of overdue receivables.

An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Honeywell Automation India Ltd for FY2009-20.

Over FY2009-20, Honeywell Automation India Ltd reported a total cumulative net profit after tax (cPAT) of ₹2,041 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹1,660 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

 

The Margin of Safety in the Business of Honeywell Automation India Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of Honeywell Automation India Ltd, an investor would notice that the company has consistently had a very high SSGR of 100% to 300% over the years. One of the key reasons for very high SSGR for the company has been its very high asset turnover. As discussed above, Honeywell Automation India Ltd has consistently had a high NFAT of 20-30.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the net fixed asset turnover (NFAT) of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

  • SSGR = Self Sustainable Growth Rate in %
  • Dep = Depreciation rate as a % of net fixed assets
  • NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
  • NPM = Net profit margin as % of sales
  • DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

Therefore, an investor would notice that Honeywell Automation India Ltd has continuously had a high SSGR (100%-300%) over the last 10 years (FY2009-FY2020). However, an investor would appreciate that the company had been growing at a rate of 10% year on year.

As a result, investors appreciate that Honeywell Automation India Ltd would not have to raise money from additional sources like debt or equity to meet its investment requirements.

While analysing the past financial performance of Honeywell Automation India Ltd, an investor notices that the company could grow its sales from ₹1,175 cr in FY2009 to ₹3,290 cr in FY2020 without raising any additional money from debt or equity dilution. The company is debt-free ever since. The liability of ₹81 cr shown in FY2020 is due to changes in the accounting treatment of leased assets.

FY2020 annual report, page 109:

Right-of-use assets represent right to use an underlying asset during the reasonably certain lease term, and lease liabilities represent obligation to make lease payments arising from the lease.

Therefore, an investor notices that Honeywell Automation India Ltd could grow its business over FY2009-2020 without relying on outside sources of funds.

An investor arrives at similar conclusions when she analyses the free cash flow (FCF) position of Honeywell Automation India Ltd over FY2009-2020.

 

b) Free Cash Flow (FCF) Analysis of Honeywell Automation India Ltd:

While looking at the cash flow performance of Honeywell Automation India Ltd, an investor notices that during FY2009-2020, it generated cash flow from operations of ₹1,660 cr. However, during the same period, it did a capital expenditure of about ₹308 cr. Therefore, during this period (FY2009-2020), Honeywell Automation India Ltd had a free cash flow (FCF) of ₹1,192 cr (=1,660 – 308).

In addition, during this period, the company had a non-operating income of ₹299 cr. As a result, the company total free surplus cash of ₹1,491 cr (=1,192 + 299).

The company seems to have used some of the cash to pay dividends to its shareholders (about ₹207 cr excluding distribution tax over FY2009-2020) while the remaining amount has led to an increase in its cash & investments from ₹106 cr in FY2009 to ₹1,514 cr. in FY2020.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

 

Additional aspects of Honeywell Automation India Ltd:

On analysing Honeywell Automation India Ltd and after reading its publicly available past annual reports from FY2004 and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

 

1) Management Succession of Honeywell Automation India Ltd:

The company was established in 1987 as a joint venture between Honeywell, USA and Tata group. In 2004, Honeywell bought out Tata group from the venture. Since then, Honeywell group has been in charge of the operations of the company.

While analysing the history of Honeywell Automation India Ltd, an investor notices that since then, professionals from the ranks of Honeywell group have joined the company in the leadership position, managing director, and have guided the company.

The current managing director of Honeywell Automation India Ltd, Mr. Ashish Gaikwad had joined the company as a software engineer. He was appointed as managing director in 2016.

FY2020 annual report, page 10:

Mr. Ashish Gaikwad was appointed as Managing Director, Honeywell Automation India Limited (HAIL) in 2016.

Mr. Ashish Gaikwad began his career as a software engineer with Honeywell Process Solutions in Pune, India. Over the years, he has served Honeywell’s customers in multiple roles of increasing responsibility in several geographies including India, Southeast Asia, Asia Pacific, and the U.S.A.

Before, Mr. Gaikwad, Mr. Vikas Chadha and Mr. Anant Maheshwari were in the roles of managing director of the company. Both Mr. Chadha and Mr. Maheshwari had joined the company from Honeywell group and later on left the company to take on other roles within Honeywell group.

FY2013 annual report, page 4:

Mr. Vikas Chadha has been with the Honeywell Group based at Delhi since the last 5 years and has held various positions such as Director – South Asia Security System; Regional Director – South Asia Honeywell Security Systems, Honeywell International India; Regional General Manager – Honeywell Building Solutions, Honeywell Automation India Ltd.

FY2009 annual report, page 3:

Mr. Anant Maheshwari has been with the Honeywell Group based at Delhi since the last 6 years and has held various important positions such as Director – Business Development, Honeywell International India; Director, South Asia – Honeywell Security and most recently he was Managing Director – ADI Asia Pacific.

Therefore, an investor notices that the Honeywell group has a vast pool of professional talent spread across its multiple entities across geographies. The group keeps appointing these professionals in charge of its different units for a certain tenure and then moves them after a few years to a different role in other entities.

Mr. Vikas Chadha resigned from the company in FY2020 to join a different role in Honeywell group.

FY2020 annual report, page 17:

Resignation of Mr. Vikas Chadha (DIN:06624266) and Mr. Brian Buffington (DIN:08060965) (Non-Executive Directors) with effect from close of business hours on October 21, 2019 as they moved to a different role within Honeywell Group Company.

Therefore, an investor would notice that Honeywell Automation India Ltd benefits from the vast talent pool of Honeywell group for its leadership position. Such an arrangement seems to ensure constant availability of professional talent to lead the company in future.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

 

2) Global corporate overheads of Honeywell group:

While analysing the expenses of Honeywell Automation India Ltd, an investor notices that over time a significant amount of expenses have been charged as “corporate overhead allocations”. The following table shows that during FY2009-2020, the company has charged about ₹873 cr as corporate overhead allocations.

Honeywell Automation India Ltd Global Corporate Overheads During FY2009 2020

According to the company, these expenses pertain to the services of Honeywell group companies used by Honeywell Automation India Ltd.

FY2009 annual report, page 38:

With effect from previous year, the Company has accounted for corporate overhead allocation, in respect of various services rendered by Honeywell group companies.

An investor would notice that in the absence of break-up/details of the services charged under “corporate overhead allocations”, this expense becomes a black box. There is no means for an investor to assess whether these expenses are justified. It looks like a case similar to transfer pricing, where companies use products and services provided by their global entities in different regions. Transfer pricing has always invited disputes because many times instead of fair market value, many other considerations enter into the picture when companies allocate values to the products & services of one region utilized by other regions.

Under transfer pricing, companies may allocate a higher share of expenses to companies that are profitable so that the other loss-making entities of the group may also show good financial performance. Other similar consideration might go into deciding how much “corporate overhead” would be charged to Honeywell Automation India Ltd.

Therefore, an investor may monitor “corporate overhead allocations” going ahead and may seek further clarifications from the company to understand this expense properly.

Further advised reading: How to read the Annual Report of a Company

 

3) Instances of wrongful allocation of costs to different projects by Honeywell Automation India Ltd:

While analysing the financial history of the company, an investor notices that in FY2015, the auditor of the company highlighted that Honeywell Automation India Ltd had done wrongful allocation of costs to its projects, which has led to inflation of its revenues and profits. According to the auditor, the company’s profits were inflated by about ₹67 cr.

FY2015 annual report, page 50:

During the period ended March 31, 2015, the Company determined that certain costs had been recorded to incorrect projects and conducted a review to determine the impact of the same. Following conclusion of the review, adjustments have been made in these financial statements to reduce revenue by Rs.5,450 lakhs and profit before tax by Rs.6,729 lakhs.

Further advised reading: How Companies Inflate their Profits

The auditor highlighted that the internal controls of the company related to the purchase of inventory and sales of goods and services in some of the projects were weak.

FY2015 annual report, page 21:

Except for deficiencies noticed during the year with regard to purchase of inventories and for sale of goods and services in certain projects of the Company following the percentage of completion method…

The company acknowledged these its internal controls were weak, which needs strengthening.

FY2015 annual report, page 11:

The Company is in the process of enhancing internal controls to minimize the risk of such incorrect recording of costs in the future

It is interesting to note that FY2015 was the year when Honeywell Automation India Ltd had changed its statutory auditor from PWC to Deloitte.

FY2015 annual report, page 10:

M/s. Price Waterhouse & Co Bangalore LLP has completed 10 years as Statutory Auditors of your Company…… It is, hence, proposed to appoint M/s Deloitte Haskins & Sells LLP (Firm Registration No. 117366W/W-100018) as the Statutory Auditors for a period of 5 years

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

An investor would note that whenever there is a significant change in the supervision/auditor, that is the crucial time when many otherwise unexpected things come out from the financials of companies.

Previously, in 2004, when Honeywell took over control of the company by buying out Tata group, then after the takeover, Honeywell noticed that lot receivables were unrecoverable but still shown as good. In addition, the company noticed that significant amount of inventory was non-usable; however, it was not written off. This was despite the management of the company being in the hands of reputed groups like Tata and Honeywell since 1987.

As a result, in FY2004-FY2005, Honeywell Automation India Ltd wrote off about ₹40 cr of receivables and inventory.

FY2005 annual report, page 12:

EBIDTA has shown a rise from the previous year despite high provisions for bad debts and write off of obsolete inventory, due to the Company moving towards a more conservative provisioning regime. This transition took place from Dec 04 to Dec 05. Total provisions/write-offs made by the company towards bad debt/inventory amount to Rs. 21.0 cr. (pr. full year – Rs.19 cr). While some provisions are expected to be there in future as well, its extent is expected to be lower.

An investor would notice that many times, the key problems in the previously reported financials are highlighted when there is a major change in management or auditors. In FY2004-2005, Honeywell Automation India Ltd disclosed that it had to write-off a significant amount for bad receivables and obsolete inventory, which was previously shown to be good. This was despite the company being under the management by reputed business houses since its inception in 1987.

Therefore, going ahead, an investor should be cautious. The company has been under the current management for a long time and has consistently had significant delays in its receivables. Classification of delayed receivables as good or doubtful is management’s choice. Investors may not have any credible method of determining whether the classification by the management into good or doubtful receivables is correct.

It is advised that an investor should do an in-depth study of all the sections of the annual reports of the company so that she may get to know about anything out of ordinary in the financial reporting.

An investor would acknowledge that accounting is a complex field whereby changing a few assumptions, companies can give a different picture to the reported financials. There have been instances in the past when Honeywell Automation India Ltd changed its accounting assumptions, which directly led to an increase in profits.

FY2005 annual report, page 26:

Revenue, that was hitherto recognized under Percentage of Completion method based on billing milestones reached, is now recognized in the proportion that costs incurred on the contract bear to the estimated total contract costs. Consequent upon the change, profit before tax for the year is higher by Rs. 27,951 thousand as compared to the method of accounting followed till the previous period.

In addition, an investor would appreciate that the previously discussed issue of transfer pricing is also one such area where companies can change the reported financial position of their entities by shifting expenses from one entity to another.

In the past, there have been instances where Honeywell group has utilized the funds of Honeywell Automation India Ltd for the benefit of its other group companies.

 

4) Usage of funds of Honeywell Automation India Ltd by other group companies:

While reading the past annual reports of the company, an investor notices that at multiple instances Honeywell Automation India Ltd gave inter-corporate loans to other Honeywell group entities.

In FY2007, Honeywell Automation India Ltd gave inter-corporate deposits to of ₹32.5 cr to group companies (FY2007 annual report, page 30):

  • Honeywell Turbo Technologies (I) Pvt. Ltd: ₹18.5 cr
  • Honeywell Turbo (India) Pvt. Ltd: ₹14 cr.

In FY2008, Honeywell Automation India Ltd gave inter-corporate deposits to of ₹509 cr to group companies (FY2008 annual report, page 28):

  • Honeywell Turbo Technologies (I) Pvt. Ltd: ₹505 cr
  • Honeywell Turbo (India) Pvt. Ltd: ₹4 cr.

In FY2009, Honeywell Automation India Ltd gave inter-corporate deposits to of ₹55.4 cr to group companies (FY2009 annual report, page 28):

  • Honeywell Turbo Technologies (I) Pvt. Ltd: ₹45.9 cr
  • Callidus Technologies India Pvt. Ltd: ₹9.5 cr.

In FY2010, Honeywell Automation India Ltd gave inter-corporate deposits to of ₹78.7 cr to group companies (FY2010 annual report, page 28):

  • Honeywell Turbo Technologies (I) Pvt. Ltd: ₹78.7 cr

In FY2011, Honeywell Automation India Ltd gave inter-corporate deposits to of ₹3.8 cr to group companies (FY2011 annual report, page 27):

  • Honeywell Controls and Automation India Pvt. Ltd.: ₹3.5 cr
  • Matrikon Industrial Solutions India Pvt. Ltd: ₹0.3 cr.

In recent years, Honeywell Automation India Ltd has not disclosed any such transaction of giving money to other group companies. However, we believe that an investor should keep a close watch on the transactions of the company with its group entities to ascertain whether the economic benefits are being transferred from one company to another.

Many times, while investing in a company belonging to large conglomerates who have their businesses spread across many group companies, investors would notice that the promoters keep doing resource transfers between their group companies. They keep using the resources and assets of one company for the usage of another group company. Many times, such intra-group transactions are due to the habit of promoters to see their entire group with multiple companies as an entity with a “pool of resources”. In order to get the best usage of the supposed “pool of resources,” the promoters keep moving money and assets out of one group company to another group company that might be in urgent need of money or can use the assets more efficiently.

In such instances of intra-group transfer of money or assets, the public shareholders of one company may think that the resources belonging to their company are being used for the benefits of another company. However, the promoters may not look at these transactions from this same perspective. For them, it might be a question of shifting assets from one group company to another company that might use them more efficiently. In the promoters’ mind, the thought process would be to get the best value of the “pool of resources” spread across their multiple group companies.

To understand more about such intra-group transfers of money & assets and to see live examples, an investor may study our analysis of National Peroxide Ltd belonging to Wadia group, Ashok Leyland Ltd belonging to Hinduja group, and Century Textiles & Industries Ltd belonging to B.K. Birla group.

In the case of National Peroxide Ltd, the Wadia group shifted money and equity shares of their group companies from one entity to another to make the best use of it from the overall group perspective. It involved taking loans in National Peroxide Ltd and then lending them further to other group companies like GoAir.

In the case of Ashok Leyland Ltd, the Hinduja group shifted entire business divisions and other assets from one company to another to make the best use of it. It involved shifting the foundry business first from Ashok Leyland Ltd to Hinduja Foundries Ltd and then shifting it back to Ashok Leyland Ltd after almost 10 years.

In the case of Century Textiles & Industries Ltd, the B.K. Birla group hived off its entire business units like cement division and rayon textile division to other Birla group companies: Ultratech Cement Ltd and Grasim Industries Ltd respectively without any independent bidding for those assets. The promoter would have the thought process that these units of Century Textiles & Industries Ltd would perform better under other group companies. Therefore, they shifted these assets out from Century Textiles & Industries Ltd even when many minority shareholders were not happy at the valuation.

Therefore, we believe that whether an investor likes it or not, when she invests in companies belonging to large conglomerates, then she should be ready to witness intra-group transactions where assets like cash and business units are moved by the promoters from one entity to another in the manner they seem best to get the maximum value out of it.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

 

5) Significant travelling expenses by Honeywell Automation India Ltd

While analysing the profit & loss statements of the company over the years, an investor notices that the company is spending about 7%-8% of its revenue at travelling & conveyance expenses.

The below table shows the amount spent by Honeywell Automation India Ltd over FY2009-2020.

Honeywell Automation India Ltd Travelling Expenses During FY2009 2020

When an investor compares the travelling expenses as a percentage of sales for Honeywell Automation India Ltd with other mid-size information technology companies (Persistent Systems and Mindtree) or large-size IT companies (Infosys and TCS) or another high-tech electronics manufacturer (Bharat Electronics Ltd), then she notices that the travelling expenses of Honeywell Automation India Ltd are definitely higher than these companies.

Travelling Expenses Comparison

An investor notices that the travelling expenses of almost all other analysed companies are in the range of 1%-4% of sales, which is significantly lower than 7-8% of sales for Honeywell Automation India Ltd.

In FY2020, Honeywell Automation India Ltd, spent about ₹250 cr on travelling when it had a total of 3,310 employees.

FY2020 annual report, page 17:

As on March 31, 2020, the Company’s employee strength was 3,310….

Assuming all the employees travel throughout the year, then it amounts to about ₹7.60 lac of travelling expenses per employee in FY2020. However, an investor may appreciate that the number of employees travelling would be less. Assuming 20% of the employees travel to client/project sites, then the travelling expenses per travelling employee in FY2020 come to about ₹38 lac, which looks high.

An investor may seek further details from the company about significantly higher expenses of Honeywell Automation India Ltd when compared to other companies.

Further advised reading: Understanding the Annual Report of a Company

 

6) Impact of developments at Honeywell group-level strategies on Honeywell Automation India Ltd:

An investor would appreciate that even though by buying shares of Honeywell Automation India Ltd, she is taking exposure to the business model of the company; however, because of it being a part of the overall Honeywell group, she is exposed to the strategic developments at the level of Honeywell global.

In the past, there have been instances where developments at the Honeywell global level affected the business of Honeywell Automation India Ltd.

In FY2010, the company had to discontinue its distribution business of Automotive on Board (AOB) sensor applications as Honeywell had sold the AOB business group at the global level. (Source: Sensata Technologies Completes Acquisition of Honeywell’s ‘Automotive on Board’ Sensors Business)

FY2010 annual report, page 9:

The Company’s product distribution rights in the Automotive on Board (AOB) sensor applications have been discontinued from January 2011, pursuant to Sensata taking over the global S&C AOB business.

In FY2012, Honeywell Automation India Ltd had to agree to share its expertise and infrastructure with another Honeywell group entity as both of them targeted the same set of customers.

FY2012 annual report, page 10:

In 2012, this business also identified synergistic opportunities for a shared management and go-to-market approach with another Honeywell India entity: Honeywell Electronic Devices and Solutions (HEDS). Both these businesses target similar end markets in the commercial and residential construction, and therefore can benefit by sharing their channels and support infrastructure.

Therefore, an investor in the Honeywell Automation India Ltd should always keep her eyes open at the developments related to the developments at the Honeywell global levels. This is because any development at the Honeywell global level can have a significant impact on Honeywell Automation India Ltd that may come as a surprise to the investor.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

 

The Margin of Safety in the market price of Honeywell Automation India Ltd:

Currently (August 2, 2020), Honeywell Automation India Ltd is available at a price to earnings (PE) ratio of about 48 based on earnings of FY2020. The PE ratio of 48 does not provide any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

 

Analysis Summary

Overall, Honeywell Automation India Ltd seems a company that is one of the best for its job and as a result, the company has some very prestigious and large clients. The company has grown at a pace of 10% year on year for FY2009-2020. Nevertheless, when an investor focuses on the profit margins of the company, then she notices that it used to have high-profit margins in FY2009, which witnessed a sharp decline to 7% in FY2012. Thereafter, the profit margins have improved to 19% in FY2020.

An analysis of different business units of the company indicates that Honeywell Automation India Ltd is a supplier/value enhancer to the core infrastructure industries like oil & gas, power, automobile, commercial real estate etc. As a result, its fate is dependent on various industries that are affected by the trend of general economic activity in the country. The fact that Honeywell Automation India Ltd caters to many industries results in diversification that protects the company to some extent.

In addition, the nature of the business of the company is project-based, which leads to delays in the effect of economic slowdowns on the company. This is because; when the slowdown hits the economy, then the existing projects, which continue their construction/execution, keep providing it with the revenue & profit opportunities. It is only when the existing projects are complete or are halted due to time & cost overruns that the business of Honeywell Automation India Ltd sees the effects of the slowdown. Then, the lack of announcement of new projects due to slowdown affects the business of the company.

During the period of 2008-2009 global meltdown, Honeywell Automation India Ltd did not feel the impact during FY2008 and FY2009. Its business continued to grow in terms of both revenues as well as profitability. It was only after FY2010 that the company witnessed the impact on its projects under execution when its customers started delaying payments and it witnessed its profit margins decline from 16% to 7% in FY2012.

The project-based nature of business has led to significant delays in the collection of money by the company from its customers. As a result, Honeywell Automation India Ltd has written off more than ₹100 cr of receivables over FY2009-2020. At any point of time, about 20%-35% of its receivables are more than 90 days overdue from the day they became payable. As a result, the company is not able to convert its profits into cash flow from operating activities completely.

Nevertheless, the business of Honeywell Automation India Ltd is very asset light as relies primarily on the intellectual power of human capital to add value to the customers. As a result, the growth of the company over the years has come with minimal capital expenditure in fixed assets. The company has been able to report a large amount of surplus cash flow from its business activities, which has been shared with the shareholders as dividend and the remaining is available with the company as cash & investments.

The business of Honeywell Automation India Ltd is deeply integrated with its global group entities. Developments at the Honeywell global level have a direct impact on Honeywell Automation India Ltd. In the past, there had been instances when the company had to support other group entities by giving them inter-corporate deposits. Though in recent times, the company has not reported such transactions; however, an investor should continuously keep a close watch on the intra-group transactions of the company.

Over the years, Honeywell Automation India Ltd has reported a significant amount of expense as global corporate overhead allocation, which demands further assessment by the investors. Similarly, the company has reported very high travelling expenses every year, which demand deeper due-diligence by the investor.

In the past, there have been instances where the company could report higher profits due to wrongful allocation of costs to projects. The company acknowledged that these were due to weak internal controls. An investor should keep a close watch and study the annual reports in-depth so that she may identify anything out of ordinary in the reports.

Going ahead, we believe that investors should keep a close watch on the profit margins of the company. The investor should closely track the intragroup transactions within Honeywell group as well as the developments at Honeywell global level that may affect the business of Honeywell Automation India Ltd. During economic downturns, an investor should keep in mind that it may take some time before its impact becomes visible on the business of Honeywell Automation India Ltd.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Honeywell Automation India Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

I hope it helps!

Regards,

Dr Vijay Malik

P.S:

 

DISCLAIMER

Registration status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of financial interest in the Subject Company:

Currently, I do not own stocks of the companies mentioned above in my portfolio.

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“Peaceful Investing” approach is the result of my experience of more than a decade in stock markets. I believe that the biggest challenge faced by investors is “scarcity of time” for stock analysis and “Peaceful Investing” keeps it in mind.

This approach aims to find such stocks, where once an investor has put in her money, then she may sleep peacefully. If later on, the stock prices increase, then the investor is happy as she is now wealthier. On the contrary, if the stock prices decline, even then the investor is happy as she can now buy more quantity of the selected fundamentally good stocks.

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