United Technologies Corp. (NYSE:UTX) is one of the leading suppliers of high technology products and services to building systems and aerospace industries across the globe. The company seeks to drive its business and financial return growth through organic development and acquiring complementary businesses. The company has divided its business into two areas: commercial and aerospace. The company has a diversified client base, which includes sales made at the government level and to retail clients. The company has recently announced its second-quarter results for the fiscal year 2014.
In my article, I will analyze the recent quarterly performance of the company and look into its future growth prospects.
Recent Performance At A Glance
UTX has some of the top notch brands under its umbrella, which fortifies the company's market position on an international level as it continues to garner nearly 60% of its total revenue base from overseas sales. This also shows that the company is extensively geographically diversified and not dependent on a single country's economy for its sales.
The company's top line witnessed total growth of 7% and reported net sales of $17.2 billion in the second quarter of the fiscal year 2014, up from $16 billion in the corresponding period last year. This growth was primarily driven by the organic sales growth in the Aerospace Systems segment due to higher commercial aerospace OEM and volumetric equipment growth in the US region and China. New equipment orders received at Otis were up by 3% on the back of 44% growth seen in the North American region and under the Aerospace Systems segment, commercial space orders secured had also gone up by 28% during the second quarter of 2014.
Additionally, China is projected to lead the upcoming demand growth in the emerging markets coupled with the economic recovery in the US on the back of strong consumer and commercial construction in 2014.
Moreover, the acquisition of Goodrich has been the right fit for UTX as it completes the range of aerospace products provided by the company. Apart from the government, the company has secured some big customers like The Boeing Company (NYSE:BA) and Airbus. Approximately the government and these two companies contribute almost 41-44% of the Aerospace Systems segment's annual revenue. Recently, the company has been awarded another contract by Boeing to extend its provision of complete nacelle systems for the 787 Dreamliner to cover the 787-10 version. Based on UTX's high-quality dispatches in the past, the company has been able to secure "the next leg." This is likely to add to the company's brand equity and its top and bottom line growth.
However, at the moment the deficit reduction measures adopted by the US government are focusing on curtailing the US Department of Defense spending which is likely to negatively affect the company's military businesses in the future.
Source: SEC Filings 2014 10-Q
On the face of it, the company seems to have experienced a compression of 300 basis points in its gross margin. However, adjusting the results for the one-off estimate revision of arrangements signed with the Canadian government for the Cyclone helicopter program, the underlying gross margin squeezed by 47 basis points.
Source: SEC Filings 2014 10-Q
UTX has an active focus on its research and development activity particularly in the aerospace business. As sales continue to grow, the company has expanded its R&D budget to keep up with its growing scale and to come up with better innovative products. Also, the company's back end efforts continue to translate into higher top line and bottom line figures as exhibited by the new contract secured from Boeing.
The company's debt to capital ratio has also plummeted to 36% during the most recent quarter, compared to 43% in the same period in the prior year due to lower debt level. This is a positive signal for the common shareholders as the free cash flow conversion to equity increases as the financial leverage goes down. The earnings are directly passed on to the equity investors with lesser amount being shared with the outside parties.
Overall, the net margin has improved to 9.77% during the period under discussion, an increase of 7 basis points from the same period a year ago.
The two major segments, namely Otis and Aerospace Systems, contribute the highest operating margin i.e. 20% and 16.6%, respectively. The solid demand flowing in from increased air travel and increasing business confidence is expected to increase the demand for airplanes and hence, translate into increased profits for the company. This is likely to counterbalance the defense spending budget squeeze.
The solid growth in consumer confidence and commercial construction in US and China is anticipated to bring in higher demand for the company's products and services. Moreover, Europe is also recovering and returning to normal growth phase but at a slower pace.
Based on the positive global outlook and the company's strong, balanced and diversified portfolio of business, it stands in a good position to benefit from the favorable global demand trends. Moreover, the company is undervalued as it continues to trade at a P/E "ttm" of 17.36x while the industry's normal level is 25.57. The company is also generating a 3.24% higher return on equity than its industry peers.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.