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Summary

  • United Technologies' second quarter results are in line with expectations.
  • Investors worry a bit about softer organic sales growth as well as order intake.
  • Shares are fairly valued at multiples being equivalent to the market. Leverage following Goodrich deal limits the options for very high dividends or more aggressive share repurchases.

United Technologies Corp (NYSE:UTX) reported a second quarter earnings report last week which was roughly in line with expectations. Yet investors are worried about slower organic sales growth and a reduction of the order intake.

Given the modest operational performance, amidst a bit of leverage on the balance sheet, I remain cautious and think the valuation at market-wide valuation multiples is fair.

Second Quarter Highlights

United Technologies posted second quarter sales of $17.19 billion, up 7.4% from last year. Analysts were expecting sales to rise towards $17.3 billion.

Reported earnings attributable to common shareholders improved by 7.7% to $1.68 billion. With a roughly equal share base outstanding, this resulted in earnings advancing to $1.84 per share. Reported earnings per share were in line with consensus estimates.

The Sikorsky unit had a negative $0.31 per share impact on earnings due to adjustments to the Canadian Maritime Helicopter Program, offset by a 2009/2010 positive tax adjustment thanks to a dispositions. All of this had a net flat impact on reported earnings.

A Solid Performance Across The Business

Overall United Technologies has seen a solid performance across its main business units, with most of them posting growth. Overall sales growth is explained by a 3% increase in organic sales, a 5% contribution from the Canadian Maritime Helicopter Program, offset by divestitures which subtracted a percent from sales.

The company's largest business, which is UTC Climate, Controls & Security posted sales of $4.43 billion, down 2.5% on the year before. Despite the shortfall in topline sales, the business improved earnings by 8.4% to $815 million, resulting in operating margins of 18.4% of sales. Margins were up substantially thanks to the benefits from past restructuring and cost cutting efforts.

Despite the ongoing growth in aviation, the company's Pratt & Whitney unit posted a modest decline in sales which fell by 0.9% to $3.59 billion. Operating earnings were down sharply as they fell by 23.8% to $432 million, with margins compressing to 12.0% of sales. The unit is facing more difficult times amidst lower military sales, among others.

Sales at Otis were up by 7.2% to $3.36 billion as operating earnings rose by 6.6% to $693 million. The lift business remains very profitable with margins of $20.6%. Yet margins were down a bit amidst continued pricing pressure.

Aerospace Systems posted sales of $3.64 billion, up 9.5% compared to last year. The unit posted solid operating leverage with operating earnings advancing by 20.6% to $602 million, for operating margins to 16.6%. Organic sales growth of 9% was achieved thanks to commercial sales being up in the double digits amidst a modest fall in military sales.

The Sikorsky helicopter unit posted a 52.2% growth in sales to $2.38 billion. Reported losses came in at $317 million versus earnings of $156 million reported least year. Of course this was largely the result of cumulative adjustments on contracts with the Canadian Government's Maritime Helicopter program. This added $830 million in sales and $438 million in losses to this quarter's results. Adjusting for this sales were down a percent amidst further losses amidst restructuring costs.

Total gross profits were down to 24.8% of sales, down from 27.8% of sales last year driven by restructuring costs among others. Despite the gross margin compression, UTX showed strong cost control thanks to an impressive reduction in selling, general and administrative expenses despite the growth in topline sales.

As such operating profits were down by 6.0% to $2.35 billion. The reason why net earnings were up compared to last year was the much lower effective tax rate of 16.7% of operating income versus 28.2% as reported last year.

Valuation Of UTC

At the end of the quarter, UTC held nearly $5.0 billion in cash and equivalents. The company has quite some debt outstanding, a total of little over $20 billion which results in a net debt position of around $15 billion.

On a trailing basis the company has posted sales of $64 billion on which it has posted earnings $5.8 billion. With 915 million shares outstanding, and shares trading at $109 per share, equity in the business in valued at $100 billion.

This values equity in the business at 1.6 times annual sales and roughly 17-18 times trailing earnings.

Continued Growth, Reducing Cyclical Exposure

Over the past decade, United Technologies has steadily grown its business thanks to a combination of organic growth as well as acquisitions. Sales have grown from about $37 billion in 2004 to about $65 billion this year, growing sales at 5-6% per annum on average.

Yet the company remains very much cyclical, as it took United Technologies until 2013 to surpass 2008's annual sales results. Earnings have grown a bit more rapidly, more than doubling to $5.8 billion on a trailing basis. Investors saw some additional earnings growth, thanks to cumulative repurchases of 10% of the outstanding share base.

Of course future growth potential and current sales growth is driven by the 2011 deal to acquire Goodrich Corporation in a $18.4 billion deal, creating more exposure to the structurally attractive aerospace business. The more stable and faster growing business should make UTX less exposure to economic cycles going forwards while boosting its growth profile.

Final Takeaway

Long term investors have seen solid returns, but over a shorter time frame returns have been mixed. Shares are only up 4% over the past year, at a time when overall markets were showing a very strong performance while shares are down 4% year to date.

Despite the fact that CEO Chenevert increased the earnings guidance to $6.75-$6.85 per share, investors and analysts are not impressed with analysts expecting earnings to improve to as much as $6.86 per share.

The disappointment this past week was driven by mixed comments about the order intake in its major businesses. Furthermore the 3% reported organic sales growth represented a slowdown from the 5% reported in the first quarter. Other key metrics, such as the hoped expansion of Otis in China has been disappointing with orders being flat this year. This is amidst at cooling of the Chinese economy, while the performance at Pratt has been soft as well given recent engine issues.

All of this combined with the fairly leveraged balance sheet, and the valuation which is in line with the wider market, creates few triggers for further upside at this point in time. Deleveraging does not allow for premium dividends or a rapid pace of share repurchases, while the operational performance is not optimal at the moment as well.

As such, United Technologies does probably not deserve a greater valuation multiple being attached to its shares at the moment, creating a fair valuation at the moment despite the suboptimal share price performance in recent times.

Source: United Technologies - Limited Appeal Following Recent Underperformance As Valuation At Par With The Market Is Fair