Shares of Honeywell International Inc. (NYSE: HON) have underperformed the rest of the market over the past six months, languishing in negative territory for most of the fall. This decline has been driven by a combination of factors, including investor nervousness regarding the company’s upcoming leadership change and some weakness in the aerospace segment that has pressured Honeywell’s profit margins.

#-ad_banner-#But looking out over the next four to eight quarters, shares of the New Jersey-based industrial conglomerate certainly look attractive. HON stock is priced at just 15 times fiscal 2017 estimates, compared to a P/E of 18 for the S&P 500 Index. And not only do those estimates imply an 8% year-over-year increase in earnings per share, but Honeywell stock will also pay an attractive 2.4% dividend yield for your patience.  

What’s more, the economic and fiscal policies that could be implemented under President-elect Donald Trump can also boost Honeywell’s standing within the industrial sector. With the investments the company is making in areas such as technology and automation, Honeywell stands to recoup those investments in the form of lower costs and operating efficiencies that can boost long-term earnings per share. Put all of these “what ifs” together, and suddenly you have a cheap stock that pays a strong yield that can surprise investors in 2017. But is Honeywell the best stocks to buy for 2017?

Where Things Stand Today
Honeywell failed to excite investors with breathtaking third-quarter earnings results, which came in at $1.67 per share on revenue of $9.8 billion (up 2% year over year). Depending on the metrics you follow, the company either missed third-quarter EPS by a penny or reported in-line results. From my vantage point, however, and understanding the company’s history, Honeywell’s third-quarter results were just as expected.

Like its closest peers, which are also struggling, Honeywell is working to navigate a weak pricing environment. In the weeks leading up to the announcement, management lowered guidance, which the company attributed to a combination of a sluggish economy and the ongoing weakness in the oil and gas industry. These were, and continue to be, familiar headwinds and not much of a surprise, and led to third-quarter revenue falling about 3%.

Each of Honeywell’s business segments suffered declines except for the home and building technology business, which grew 5% on an organic basis, thanks to better-than-expected results in the distribution segment. As expected, the Aerospace business underperformed as revenue declined 6% year-over-year. The Aerospace business also suffered margin erosion of more than three percentage points, falling to 18.4% from 21.8% a year ago. But Honeywell, founded more than 100 year ago, has been through these issues before. One weak quarter does little to suggest that this company is in serious trouble.

The Change At The Top Won’t Change Strategy
Investors are understandably nervous about the upcoming change at CEO and the potential disruption it may cause in terms of business approach and, frankly, whether the new CEO can carry the torch effectively. David Cote recently announced he would retire as CEO in 2017, which isn’t much of a surprise given the various stages of restructuring Honeywell had undertaken over the past several quarters. Nor was it a surprise that Darius Adamczyk was appointed as the next CEO.

Investors, however, were surprised by the timing of the announcement, particularly because Honeywell has yet to complete Cote’s planned move towards automation and software. It is not yet clear whether Adamczyk will maintain that course or decide to put the company on a different path.
    
That said, I’m willing to bet Adamczyk will keep the company’s focus on automation and software. This would be Honeywell’s quickest path towards higher profit margins, given that the company already has invested heavily in digitizing not only its factories and buildings, but also several of its core segments. What’s more, Adamczyk, a former software engineer, is likely better suited to lead Honeywell through this transition than Cote. And investors shouldn’t be surprised if the outcome of the move towards automation and software arrives quicker and delivers higher-than-expected returns.

Can Honeywell’s Returns Overflow?
The CEO transition will pose a near-term challenge, but the market overlooked the fact that Honeywell’s management, despite lowering Q3 guidance, said that the company is in a position to deliver improving results over the next five quarters. Projecting these changes out over the next eight quarters, it’s tough to ignore the value.

The company is projected to grow earnings at an average annual rate of 9% in the next five years, meaning earnings per share growth will accelerate beyond the projected 8% growth for fiscal 2017. Likewise, I expect Honeywell’s revenue to trend higher the 4.5% to 5% range, while growth in free cash flow can reach 6% to 7%. These projections support a fair value of around $127 to $130 per share, or 13% to 15% higher than current levels. My forecast compares to the analyst consensus 12-month price target of $124.

These projections may yet be conservative to the extent that the company can successfully execute its move towards automation and software, which can boost Honeywell’s profit margins, allowing Honeywell to invest in areas where its R&D can extract significant market opportunities.

Risks To Consider: There’s quite a bit for investors to digest regarding the CEO change and the company’s ability to execute its move toward automation and software. And while the energy sector has rebounded slightly over the past three months, there’s no guarantee that oil prices won’t remain at a level that will prolong the pressure on Honeywell’s core businesses.

Action To Take: Honeywell should be kept on the watch list of investors who are looking for an undervalued industrial stock that is trading at a meaningful discount to its long-term potential and also pays a strong dividend yield.

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