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Investors in United Technologies (UTX) saw a very modest sell-off on Monday after the industrial company released its third quarter results. The company is moving along just fine, but the solid momentum this year has pushed up expectations a bit too much.

As shares are more than fairly valued, I remain on the sidelines.

Third Quarter Results

United Technologies generated third quarter revenues of $15.46 billion, up 2.8% on the year before. Revenues came in far below consensus estimates of $16.18 billion.

Income from continuing operations rose by 13.5% to $1.42 billion. As such, diluted earnings per share rose from $1.37 last year to $1.55 per share, beating consensus estimates by a penny. Excluding the impact of one-time items and restructuring costs, earnings were up by 19%. CEO and Chairman Louis Chenevert commented on the third quarter performance:

"Our solid year to date results, additional restructuring savings, and improving sales trends give us confidence to increase the lower end of our earnings per share range."

Looking Into The Numbers

Revenue growth was mainly driven by acquisitions, which added 2% in growth, while organic growth came in around 1%.

Operating margins rose by 170 basis points to 15.3% of total revenues on higher Aerospace margins as well as general cost cuts.

Overall growth was entirely driven by Aerospace Systems which saw its revenues increase by a quarter to $3.3 billion. This in turn was driven by the $16.5 billion acquisition to acquire Goodrich last year. Sales at elevator segment Otis were solid as well, offset by weakness at the Pratt & Whitney unit.

All segments managed to improve operating earnings with exception of Sikorsky. Notably the aerospace business performed well, while Pratt & Whitney increased earnings as well despite the falling revenues.

Looking Towards The End Of The Year

UTX now sees full year revenues of approximately $63 billion for the year, down from a previously estimated $64 billion, due to the weakness in the military aerospace market and a slower recovery in Europe. On average, analysts were looking for revenues of $63.9 billion. Note that fourth quarter organic revenue growth is expected to re-accelerate towards 3-4%.

Full year earnings are seen between $6.10 and $6.15 per share, with the lower end of the range being upped from a previous guidance of $6.00-$6.15 per share. Analysts were looking for earnings of $6.16 per share.

Valuation

United Technologies ended its third quarter with $4.6 billion in cash and equivalents. Total debt stands at $21.2 billion for a net debt position of $16.6 billion.

Revenues for the first nine months of the year came in at $45.9 billion, up 11.1% compared to a year before. Income attributable to common shareholders rose by 38.5% to $4.3 billion.

Trading around $106 per share, the market values United Technologies at around $97 billion. This values the company at 1.5 times annual revenues and 16-17 times annual earnings.

United Technologies currently pays a quarterly dividend of $0.59 per share, for an annual dividend yield of 2.2%.

Some Historical Perspective

Long term shareholders in United Technologies have seen very solid returns. Shares rose from $40 in 2004 to double towards $80 in 2007. Shares fell back towards $40 during the financial crisis to rise to highs of $112 earlier this year.

Shares have already risen some 30% this year.

Between 2009 and 2012, United Technologies increased its annual revenues by 10% to $57.7 billion. Earnings rose by some 34% to $5.1 billion.

Investment Thesis

Investors were not impressed with the results of United Technologies. This is despite the fact that it raised the low end of its full year earnings forecast after the government shutdown and weakness in the defense business. These factors prompted the company to cut the revenue guidance by a billion.

In total, United generates about 18% of revenues from the government, with spending cuts threatening to impact these revenues. Note that CFO Hayes confirmed the revenue shortfall is entirely attributed to the government with the rest of the business doing well.

The effects of the government shutdown cost about a week of production for the Sikorsky unit, but the impact on earnings was less than a penny. Even so, orders fell some 50% for spare parts so far this year, with the military being by far the biggest client of the unit.

To offset some weakness across the business, United expects to restructure for about $500 million this year, as it looks to reduce the total headcount by 2,000 workers; about 1% of its workforce.

Following the acquisition of Goodrich, for about $18.4 billion in total, United Technologies has temporarily increased leverage to levels which it does not think are desirable. This has resulted in a reduced pace of share repurchases as the company is repairing its balance sheet. Any future deals will most likely again occur in the aerospace business, with a focus on emerging markets. United expects to deliver on $250 million on synergies for the year following the Goodrich deal and remains on track for synergies of $500 million per annum by 2016.

So United Technologies is slowly transforming from an industrial conglomerate to more and more an aerospace company, although other industrial segments like Otis elevators remain key assets for the time being.

Back in December of 2012, I last took a look at United's prospects. At the time, I concluded that the 2013 outlook highlights the long term potential of the business. The outlook given last year valued UTX at 1.1 times sales and 13-14 times earnings, with synergies from the Goodrich (GR) deal being able to boost earnings per share going forward.

Over the past year, shares have risen from levels around $80 to current levels around $105. As such, the dividend yield has fallen despite the recent dividend hike. Right now, I remain on the sidelines as shares are more then fairly valued and the dividend yield is not appealing enough.

Source: United Technologies - Fair Valuation Amidst Solid Execution