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United Technologies (UTX) continuously outperformed the S&P 500 index over the past one year. Its stock returns increased 37.5% year over year compared to the S&P 500 index's 16.69% returns. Going forward, we expect that the company will continue this performance with its growth aspects. One such growth factor includes its recent deal with the U.S. government to manufacture engines for U.S. military fighter planes.

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A bulky contract

United Technologies' business unit Pratt and Whitney manufactures components for aircrafts globally. It provides engines to the F-35 fighter planes of Lockheed Martin (LMT). The U.S. defense forces use F -35 planes as a weapon system for the Navy, Marines, and Air Force. On August 26, 2013, Pratt and Whitney reached an agreement with the U.S. government to provide 39 engines. Thirty-six engines are for F-35 planes and three are spares. This deal is expected to be worth more than $1 billion and is meant for the sixth batch of F -35 fighter planes. The U.S. government finalized the order of the sixth batch of F-35 planes with Lockheed in July 2013.

The government also finalized the order for a seventh batch with Lockheed, along with sixth one in July. However, the government hasn't disclosed details regarding the contract for engines. Going forward, F-35 government contracts will benefit Pratt and Whitney since the U.S. government purchases engines for F-35 planes from this United Technologies business unit only.

Last year, military engines contributed around 28.57% of Pratt and Whitney's total revenue of $14 billion. With the above discussed contract, we expect this revenue contribution to increase to 33.33%, which is an increment of around five percentage points. With more contracts lined up, the revenue contribution will increase in the future.

Substantiating the vitality of these contracts, Pratt and Whitney's president, Dave Hess, stated, "F-35 engine sales would account for more than 50 percent of the company's military engine revenue in coming years."

Pratt and Whitney accounted for 24.19% of the United Technologies' net revenue last year, which is the company's second highest revenue contribution. Boosting this major revenue generating segment is expected to significantly bolster United Technologies' earnings, thereby increasing its earnings per share.

Savior: F-35

In March 2013, the U.S. government cut the defense spending budget. This severely affected Lockheed Martin, which generates more than 80% of its total revenue from the U.S. government. The impact of these cuts reflected in Lockheed's backlogs, which declined 9% in the first half of 2013.

One of the major defense airplanes used by the U.S. military is Lockheed's F-35 defense airplane, which is discussed above. These F-35 planes are considered a significant defense weapon, so they might not face U.S. defense spending cuts.

According to a U.S. Air Force official, "The F-35 Joint Strike Fighter may escape from the automatic spending cuts next year."

We expect this to be a noteworthy factor for Lockheed since F -35 planes accounted for a significant 14% of the company's net revenue last year. This revenue contribution is $6.60 billion, a year over year growth of 10%. As the defense cuts shouldn't impact the F-35, we assume this growth rate to be constant for the next year, which is expected to generate revenue of $7.26 billion. Additionally, Lockheed has been making efforts to reduce its reliance on U.S. contracts. It has increased its international defense deals in South Korea and Saudi Arabia. Moreover, it expanded its business in the U.K with its acquisition of Amor Group. We have discussed these approaches in detail in our earlier articles on Lockheed, and the company is on the right track to diversify away U.S. contract dependence.

Scrutinizing dividends

United Technologies' biggest rival is Honeywell (HON). Based on dividend growth United Technologies is outperforming its biggest rival. By analyzing a company's earnings growth rate, we can examine its dividend growth rate.

1- Dividend payout ratio signifies the earnings retained by the company after paying out the dividend.

Company

Dividend Payout Ratio (trailing twelve months)

(1- Dividend Payout Ratio)

Return on Equity (trailing twelve months)

Estimated Dividend Growth

United Technologies

0.305

0.695

0.242

0.168

Honeywell

0.395

0.605

0.239

0.144

As shown in the table, the trailing twelve months dividend payout ratio and trailing twelve months return on equity are considered constant for next twelve months. Consequently, we estimate the dividend to grow by 16.8% for United Technologies and 14.4% for Honeywell for the next twelve months.

Conclusion:

The fundamentals of United Technologies look strong with the integration of big deals for F-35s. The company is also presenting a strong dividend yield compared to its nearest rival Honeywell. Considering its fundamentals and valuation, we would advise investors to comfortably rely on this stock and buy it for healthy returns.

Source: United Technologies: A Strong Defense Pick