Building And Industrial Systems Consolidation A Key Focus For United Technologies

| About: United Technologies (UTX)

At United Technologies' (NYSE:UTX) October 1 Investor and Analyst Meeting, Geraud Darnis, President and CEO, discussed United Technologies' Building and Industrial Systems consolidation. The consolidation was announced on September 23, and Geraud Darnis was appointed President and CEO of United Technologies' Building and Industrial Systems business.

Geraud has worked at United Technologies since 1983. He was previously President and CEO of United Technologies' Climate, Controls and Security business. As Climate, Controls and Security President and CEO he managed the business division's consolidation of Carrier and Fire and Security. Prior to that he held a variety of international management positions within United Technologies' Carrier and Otis businesses.

The September 2013 consolidation announcement brings together two strong United Technologies business divisions. Climate, Controls and Security was formed in 2011, through a similar business consolidation of Carrier and Fire and Security. Since 2011 the Climate, Controls and Security business has been a leading global provider for building systems. Climate provides heating, air conditioning and refrigeration solutions primarily through Carrier products. Controls delivers automated solutions for building systems management. Fire and Security also provides cost efficient and innovative solutions specifically for building systems safety. In 2Q13 Climate, Controls and Security accounted for 28% of United Technologies' total revenue and 30% of total operating income. In 2012 it accounted for 30% of total revenue and 32% of operating income.

Otis has been a subsidiary of United Technologies since 1976. It is a leading global manufacturer of elevators, escalators and moving walkways. In 2Q13 it contributed 20% to United Technologies' total revenue and 26% to operating income. In 2012 it accounted for 21% of total revenue and 33% of operating income.

The consolidation of the two businesses will benefit United Technologies in a few ways. First, the consolidation will allow the company to improve operating profit margins. Annual operating profit margins for Otis have remained fairly steady over the past three years averaging 22%. Operating profit margins in Climate, Controls and Security have improved as the Carrier and Fire and Security businesses have been integrated. Operating profit margins for Climate, Controls and Security averaged 12% over the past three years and saw improvement in 2Q13 at 17%. The consolidation of Otis and Climate, Controls and Security is expected to help further streamline business operations providing for additional improvements in operating profit margins through the consolidation of the two business units.

Business integration will be a key factor for efficiency improvements but key account cross selling will also play a significant part in revenue generation. As a consolidated organization the Building and Industrial Systems business will allow United Technologies to present a broader array of integrated building system solutions to clients.

The Building and Industrial Systems consolidation comes at an opportune time for the company with its key focus for growth on the urbanization trend occurring specifically in the emerging markets. Through the consolidation of Otis and Climate, Controls and Security, United Technologies will have a more competitive building system solutions offering for emerging market clients helping it to better capitalize on the trend.

The consolidation of the businesses should cause little disruption to the company's overall operations and cost reduction benefits should be seen in the near-term quarters. Guidance presented by management in its 2Q13 earnings announcement was revised up to reflect the overall future growth expected for the company. Earnings projections for the year increased to $6.00-$6.15 per share from $5.85-$6.15 per share. The Building and Industrial Systems consolidation should help United Technologies more easily meet this expectation.

In the company's 3Q13 earnings report, which will be provided near the end of October, investors should watch for the effects of the consolidation on overall sales and profitability growth for United Technologies. Top line revenue growth for the company has shown a three-year compound annual growth rate (OTCPK:CAGR) of 3.25% while operating profit has grown at a CAGR of 6.41% over the past three years. The Building and Industrial Systems integration should lead to further improvements in revenue and profitability growth in future quarters.

The company's growth has helped the stock price to improve 47.59% over the three-year period ending October 2, 2013. During this time period it outperformed the Dow Jones Industrial Average by 8.25%. It also outperformed its Dow 30 competitors GE and 3M by 1.56% and 10.52%, respectively.

Given the steady state of growth that has occurred over the past three years and the potential for cost reductions and increased market capture from the Otis and Climate, Controls and Security consolidation the company seems to have increased earnings growth potential in the near term. Reliance on government resources for production in the midst of a government shutdown will also be another factor to watch specifically for United Technologies. The shutdown is affecting United Technologies' Sikorsky business, which has furloughed approximately 2,000 workers. Other parts of the business will also be required to halt production if the shutdown continues including areas of Pratt & Whitney as well as Aerospace Systems.

Given these positive growth factors and a short-term government shutdown, United Technologies appears to have a one-year price target of $108.55. In the second half of the year investors should monitor the cost reductions and increased sales produced from the consolidation as well as the effects of the government shutdown. If realization of synergies is delayed and government shutdown furloughs are extended growth could be slower resulting in decreased earnings and a reduced price target.

Note: The price target is derived from Bodie, Kane and Marcus' intrinsic value formula. The intrinsic value formula discounts the stock's projected one-year future cash flow by the risk-free rate on the one-year Treasury note and includes adjustments made for specific market assumptions including the stock's beta and market risk premium.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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