Looking at a company’s profitability is a very important step in understanding a company. Profitability is essentially why the company exists and is a key component while deciding to invest or to stay invested in a company. There are many metrics involved in calculating profitability, but for this test, I will look at Honeywell International Incorporated’s (HON) Earnings and Earnings Growth, Profit Margins, Profitability Ratios and Cash Flows.
Through the above-mentioned four main metrics, we will understand more about the company’s profitability and if this summary is compared with other companies in the same sector, you will be able see which has been the most profitable.
As Honeywell International scored five out of nine on the financial health test it was a pass, but there were a few questions raised about the company’s profitability. Honeywell: Inside the Numbers
Earnings and Earnings Growth
1. Earnings = sales x profit margin
• 2010 – $32.350 billion x 6.25% = $2.022 billion
• 2011 – $36.529 billion x 5.65% = $2.067 billion
Honeywell Internationals earnings decreased from $2.022 billion in 2010 to $2.067 billion in 2011.
2. Earnings per share = net income / shares outstanding
• 2010 – $2.022 billion / 783.90 million = $2.58
• 2011 – $2.067 billion / 774.70 million = $2.65
Honeywell Internationals earnings per share increased from $2.58 in 2010 to $2.65 in 2011.
3. Five-year historical look at earnings growth
• 2007 – $2.444 billion, 17.33% increase over 2006
• 2008 – $806 million, 203.22% decrease
• 2009 – $1.548 billion, 92.05% increase
• 2010 – $2.022 billion, 30.62% increase
• 2011 – $2.067 billion, 2.22% increase
In analyzing the growth of Honeywell International over the past five years, it is clear the company is recovering from a relatively disastrous 2008, when earnings dropped to 806 million. Over the past three years, the company has recovered nicely but is still down 18.23% from 2007 earnings.
4. Gross Profit = Total sales – cost of sales
When analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin.
• 2010 – $32.350 billion – $24.721 billion = $7.629 billion
• 2011 – $36.529 billion – $28.556 billion = $7.973 billion
5. Gross Profit Margin = Gross Income / Sales
The gross profit margin is a measurement of a company’s manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/ sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.)
• 2010 – $7.629 billion / $32.350 billion = 23.58%
• 2011 – $7.973 billion / $36.529 billion = 21.82%
As the gross profit margin decreased, it implies that management was less efficient in it’s manufacturing and distribution in the production process than the year previous. The gross margin went from 23.58% to 21.82%. As the gross margin decreased Honeywell International does not pass.
6. Operating income = Total sales – operating expenses
The amount of profit realized from a businesses operations after taking out operating expenses – such as cost of goods sold (COGS) or wages – and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses and then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.
• 2010 – $2.722 billion
• 2011 – $2.282 billion
7. Operating Margin = operating income / total sales
Operating margin is a measure of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.
If a company’s margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
• 2010 – $2.722 billion / $32.350 billion = 8.41%
• 2011 – $2.282 billion / $36.529 billion = 6.24%
As Honeywell Internationals operating margin has decreased, it leaves less cash for the company to pay for its fixed costs. As the operating margin decreased, Honeywell Inc. does not pass this metric.
8. Net Profit Margin = Net income / total sales
A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.
• 2010 – $2.022 billion / $32.350 billion = 6.25%
• 2011 – $2.067 billion / $36.529 billion = 5.65%
As Honeywell Internationals net profit decreased, it implies that the company is less profitable than it was a year ago. To pass, the net income must increase. Honeywell Inc does not pass.
9. SG&A % Sales = SG&A / total sales
Reported on the income statement, it is the sum of all direct and indirect selling expenses and all general and administrative expenses of a company.
High SG&A expenses can be a serious problem for almost any business. Examining this figure as a percentage of sales or net income compared to other companies in the same industry can give some idea of whether management is spending efficiently or wasting valuable cash flow.
• 2010 – $4.618 billion / $32.350 billion = 14.27%
• 2011 – $5.399 billion / $36.529 billion = 14.78%
As the SG&A % Sales increased, it implies that management is spending less efficiently. To pass, the SG&A % Sales must decrease. Honeywell Inc does not pass.
10. ROA – Return on Assets = Net income / total assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as “return on investment.”
• 2010 – $2.022 billion / $37.834 billion = 5.34%
• 2011 – $2.067 billion / $39.808 billion = 5.29%
As the ROA decreased from 5.34% in 2010 to 5.29% in 2011, it implies that management is not using its assets to generate enough earnings. Honeywell Inc does not pass.
11. ROE – Return on Equity = Net income / shareholder’s equity
The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.
• 2010 – $461.5 million / $10.67 billion = 23.64%
• 2011 – $609.66 million / $10.81 billion = 28.88%
As the ROE increased from 23.64% in 2010 to 28.88% in 2011, it reveals that the company is generating more profits from the money shareholders have invested. Honeywell Inc passes.
12. Free Cash Flow = operating cash flow – capital expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it’s tough to develop new products, make acquisitions, pay dividends and reduce debt.
It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
• 2010 – $4.203 billion – $651 million = $3.552 billion
• 2011 – $2.833 billion – $798 million = $2.035 billion
As the final number in free cash flow fell by 74% it raised a few questions. The main question is, did the company make any large purchases in 2011 that would reduce free cash flow? The answer is yes, On June 13, 2011 purchased EMS Technologies, Inc. (ELMG) for approximately $491 million. For more information on the purchase read, Honeywell To Acquire EMS Technologies, Inc. For $491 Million. As this is a large investment one should watch for future erosion of the margins to ensure that the company is making money on its assets.
13. Cash flow margin = Cash flow from operating activities / total sales
The higher the percentage, the more cash available from sales.
If a company is generating a negative cash flow, which would show up as a negative number in the numerator in the cash flow margin equation, then even as it is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.
• 2010 – $4.203 billion / $32.350 billion = 12.99%
• 2011 – $2.833 billion / $36.529 billion = 7.75%
As the company’s cash flow margin is positive, it does not have to borrow money or raise money to keep operating. Even though the number is positive the margin has slipped. The margin slipped due to Honeywell Internationals purchase of EMS Technologies Inc. in 2011. One of the positive aspects of the purchase is, the company still has a positive cash flow, suggesting that it will not have to borrow or raise money to keep operating. Honeywell International passes.
In analyzing Honeywell Internationals profitability, it is clear that the company profits have been recovering steadily from a low 2008. The company has had positive growth over the past three years but is still down over 18% from 2007′s numbers.
Honeywell International did not grow any aspects of the profit margins segment. As all margins decreased over last year, this is of concern. As the gross profit margin decreased, it implies that management was less efficient in it’s manufacturing and distribution in the production process than the year previous. As Honeywell Internationals operating margin decreased, it leaves less cash for the company to pay for its fixed costs. As Honeywell International’s net profit decreased, it implies that the company is less profitable than it was a year ago. As the SG&A % Sales increased, it implies that management is spending less efficiently. Honeywell International received 0 passes out of 4 on the Profit margins segment of the analysis.
Honeywell International passed one of the two aspects of the profitability ratio segment of the analysis. The company had healthy increases in its ROE suggesting that the company generated more money from shareholders investments. Honeywell International dropped in its ROA suggesting that that management is not using its assets to generate enough earnings. Honeywell International received 1 pass out of 2.
Honeywell International passed the aspects of the cash flow summary. As Honeywell International purchased EMS Technologies Inc. it decreased the company’s free cash flow. As Honeywell International made a large purchase in 2011 it will be a positive if Honeywell Inc. makes a return on the investment.
In analyzing Honeywell Internationals profitability, it is clear that the company has had some positive and some negative returns over the past five years. Some aspects of profitability are positive, but there are many aspects that declined from the year previous. These declining margins are aspects of the company to watch going forward.