Seeking Alpha
What is your profession? ×
Long/short equity, special situations, event-driven, growth
Profile| Send Message|
( followers)

United Technologies' (NYSE:UTX) Pratt & Whitney unit is sustaining its defense contracts. Recently it signed a contract with the U.S. Department of Defense worth about $231 million for the F 119-PW-100 engines, which are used to power Lockheed Martin Corporation's (NYSE:LMT) F-22 Raptor stealth fighter jet.

Along with this project, Pratt & Whitney is also expecting to sign a partial agreement with the Pentagon for operation and maintenance of engines for the seventh batch of Lockheed Martin F-35 fighter jets by the end of this year. The unit expects to produce 40 engines each in the next two production lots. For the sixth batch, Pratt & Whitney built 38 engines for F-35 fighter jets that will be delivered this quarter.

Because of the increase in volume with every new batch, Pratt & Whitney can lower the cost per engine. The cost of the sixth batch of engines was 2.5% less than the previous batch, and Pratt & Whitney expects similar results for next two batches as well.

Along with engines, the cost to manufacture other parts of this jet is also being reduced. In 2013, total cost of the project was down by $4 billion over 2012 and further reduction is expected in 2014. However, the cost is still high. The Pentagon expects the total expenditure to develop and build 2,443 F-35 jets by the late 2030s to be about $391.2 billion, roughly 68% more than its 2001 projection.

However, Lockheed Martin, Pratt & Whitney, and two key subcontractors, Northrop Grumman Corp (NYSE:NOC) and Britain's BAE Systems (OTCPK:BAESF), along with the government are drafting plans to lower the cost of the new plane. They are still working out the details and expect to unveil it early next year. By 2019, the F-35 conventional A-model's cost is expected to fall to $75 million. It currently costs $107 million.

Cost reduction is a good sign, because it will cut down total spending on this project. The U.S. defense budget is expected to be cut by $500 billion over the next 10 years due to the government's sequestration program or automatic spending cut. However, the F35 project -- the most expensive military project -- remains a priority for defense, but the production rate could stay lower due to this budget cut. The lower cost will make it price-competitive to other fourth-generation jets, helping to increase its production rate long term.

Emerging countries urbanization trend boon for the company

United Technologies expects strong sales next year from its elevator and escalator manufacturing unit, Otis. China and India are two markets with good prospects. These two countries are the world's top two in the elevator and escalator industry. In fiscal year 2013, China held 65% of global market share, while India's share was 6.8%.

In China, urbanization is increasing. At present, 51% of Chinese citizens live in urban areas, which is far behind Western Europe and the U.S., where about 80% of the population lives in urban areas. With every 1% increment in urbanization, China's urban population will increase by about 15 million. Because of the rise in urban population, demand for urban infrastructure will also increase, which in turn will increase demand for elevators and escalators.

Along with new installation, China is a big market for escalator and elevator repair and maintenance services as well. Otis China estimates there are about 2 million units in the country that require maintenance. To capture this market Otis will increase its investment in maintenance and repair by 30% over the next few years.

India is another good prospect for Otis. In terms of new equipment installation in the elevator and escalator market, India has shown a compounded annual growth rate, or CAGR, of 10.3% compared to the global market CAGR of 5.2% from fiscal year 2007 to fiscal year 2013. Otis-India is the market leader with 30% market share, allowing it to capitalize on this growth opportunity.

Current yearly elevators installation in India

47,000

Projected installation (in 2014)

51800 (@10.3% growth rate)

Potential orders Otis-India can receive

15,500 (30% of total)

Average elevator's price in India

$25,000.00

Expected revenue Otis can generate

Around $380 million

Keeping its market share constant, I expect Otis-India will generate at least $380 million in 2014, just by installing new elevators. With the increment in new installation, its maintenance and servicing business will also increase and its revenue will get a further boost.

Conclusion

United Technologies' Pratt & Whitney unit is maintaining its partnership with the U.S. defense industry. It has signed a contract for $231 million for its F 119-PW-100 engines. It also expects to sign a contract for the next batch of engines for F35 jets. All companies involved in manufacturing of the F35 jet are drafting plans to lower the cost, expecting to significantly reduce it by 2019. The cost reduction will help to reduce total project expenditures, which in turn will increase its longevity.

United Technologies' elevator unit, Otis, also has good prospects, and the company is expecting strong sales next year. China and India and are the two bright prospects for the unit as urbanization continues to increase in these two countries. Considering these growth factors, I recommend investors take a long position in this stock.

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.