United Technologies (UTX) is a multinational conglomerate renowned for its aircraft engines and helicopters. Over the last 38 years the company has pursued a comprehensive acquisition strategy diversifying its business into escalators, security and building systems. The resulting conglomerate structure allows investors to basically make a bet on steady economic growth. If it wasn't so expensive.
United Technologies ranks midfield in peer group performance comparisons. United Technologies returned 128% and Honeywell (HON) 211% over the last five years. Siemens (SI), the German industrial giant, gained 139%, 3M (MMM) 106% and General Electric (GE) just 43%. All companies operate a variety of industrial segments and all of them can be understood as market proxies due to their large- scale operations and diversified business structures.
Free cash flow
I have compiled the historical cash flows for United Technologies in the table below. Despite relatively optimistic assumptions about UTX's operating cash flow- and free cash flow to equity growth, the resulting P/FCFE of 17.75 is very rich and suggests that United Technologies is not a bargain in the conglomerate sector.
Applying a discounted cash flow model with a long-term sustainable growth rate of 4% and capital costs of 10%, the FCFE model yields an intrinsic value estimate of $100.10 per share implying 7% downside from current share price levels. The derivation of the 2014 FCFE per share as well as the assumptions about FCFE growth and capital costs are tending toward optimistic. The result may be that the implied intrinsic value of $100.10 per share is upward biased.
From an earnings perspective, United Technologies isn't a bargain anymore thanks to solid share price performance in the past. UTX currently trades at 15.6 times earnings while large-cap conglomerates with equally strong market positions in transport and aviation (General Electric, Siemens) only trade at 14.2 and 13.6 forward earnings.
Income investors might take a liking to conglomerates. Their diversified businesses lead to relatively stable cash flows as they spread business risk over a number of segments. This allows conglomerates to pay dividend yields of around 2-3%. General Electric pays nearly 3% and would make a great addition to income-oriented portfolios (and also has more upside potential than United Technologies) while United Technologies pays below the peer group average of 2.31%.
Investors looking for a cyclical investment that does well when the overall economy does well could consider an industrial conglomerate. They usually operate a set of core businesses each of which might display different sensitivities to macroeconomic conditions and phases in the business cycle. For income seeking investors conglomerates provide interesting income potential. I think United Technologies borders on being overvalued based on both free cash flow and earnings. Investors looking for an attractive conglomerate with a great dividend record, strong underlying profitability and more upside potential than United Technologies should take a look at General Electric instead.