The Simple Case For United Technologies Corp.

Sep. 3.14 | About: United Technologies (UTX)

Summary

United Technologies used its debt financing effectively to fund aggressive growth.

The operating margins aren't particularly strong, but they are improving.

The combination of share buybacks and dividend yield makes the stock attractive to retirees.

United Technologies Corp. (NYSE:UTX) is such a large company, it could seem overwhelming to new investors. The company is one of the largest suppliers for Aerospace and defense products, but it also manufactures, sells, and installs a wide range of products that ordinary people use every day. For instance, the OTIS segment handles passenger elevators. UTX is clearly holding multiple complete segments, but there are a few ways you could divide it up. The most basic is to compare commercial and aerospace. The company adds a little more insight into that split-up by further dividing up the aerospace markets with the following chart:

Rather than compare the segments, I'll help break down the company for those new investors using a five-step DuPont Analysis. As an investor, you're buying all the segments. Therefore, the place to start is with the broader trends that are impacting the company. I'll break out the metrics for the last 3 completed fiscal years and for the last 4 fiscal quarters so we can see the trends. Table 1 contains the DuPont Analysis.

Click to enlarge

Tax Burden

For anyone that isn't familiar with the DuPont framework, the tax burden and interest burden represent the portion of the income the company is able to keep when going through that line. For instance, the tax burden shows how much of "earnings before taxes" can reach "net income". In the case of UTX, the tax burden has been fairly high. The most recent four quarters are showing spikes, but the spikes are going in opposite directions, so I expect it to even out over the year. The rates of 30% to 35% are pretty high for a huge corporation. Normally, I would expect large companies to engage in more tax-dodging behaviors.

Interest Burden

UTX is using a fairly significant amount of debt judging from the interest burden. When comparing UTX to other companies, 90% is a relatively small amount of the earnings before interest for the company to keep. I regularly see values around 95% to 98% here. I'm not worried about the extra debt the company is using, though. They are still getting a very solid amount past the interest, and with interest rates being so low, I think the use of debt is prudent.

Operating Margin

The company's operating margins are in the low teens, which is fairly mediocre. For comparison, General Electric (NYSE:GE) has operating margins in the high teens to low twenties, and Honeywell (NYSE:HON) has operating margins from the single digits to the low teens.

However, operating margins can be impacted significantly by the cost of R&D expenditures. Table 2 breaks out the impact on margins if R&D could be capitalized.

Click to enlarge

The margins after removing the R&D cost are better, but they aren't dramatically better. This could be an area for the company to improve on.

Asset Turnover

Asset Turnover measures how effectively the company is using assets to generate sales. In 2011, the asset turnover was fairly strong at .91. Since then, it has dropped off dramatically. It wasn't a lack of sales, as sales have been growing throughout the period. The issue was one of increased asset base, as the company's assets ballooned from $61,542 to $90,594 (in millions) over the last 2 years, with most of the growth happening during 2012.

Leverage Ratio

The leverage ratio makes it appear that the company is highly leveraged, but the book value of assets and equity can be quite misleading for some companies. The high value of equity relative to assets is keeping the ROE figure up, but it would be helpful to know more about the leverage. Table 3 will expand the conversation by including shares outstanding and cash.

Click to enlarge

We can see that shares increased significantly and cash decreased during fiscal 2012. That isn't too surprising given the enormous increase in assets. However, we also see that equity only increased by about $10 billion. That's much smaller than the increase in assets. I think UTX may have timed their increase fairly well, since interest rates were attractive.

Table 4 will break down the leverage using the market cap of equity.

Click to enlarge

Judging from the market value for the company's equity, the company is using significant levels of debt. Note that I'm using the entire value of liabilities here, I'm not restricting it long-term debt. All assets have to be funded in one way or another. The percentages are down in 2013 from 2012, as a combination of reduced liabilities and significant increases in the share price moved the company to a less leveraged position. Overall, this was largely the result of driving large price gains for shareholders.

Earnings guidance

During the earnings call, management raised guidance for the year slightly. Prior guidance was for EPS of $6.65 to $6.85. Management raised the bottom end up to $6.75, while keeping the top end steady.

Share repurchasing

During the second quarter, the company spent $335 million on repurchasing shares. It expects to repurchase a similar volume during the third quarter. For the year, share repurchases are expected to run $1.25 billion, up from management's initial estimate of $1 billion.

Conclusion

UTX produced large gains in share price during 2013, though shares have dropped slightly this year (down 3% to 4% year-to-date). Margins have only improved slightly. Still, the company has been effective in use of debt to leverage the returns to shareholders. There is risk inherent in that debt, but UTX seems to be managing the debt well. The company has been paying down debt in the previous two quarters, and management has indicated they intend to continue reducing their debt levels over the rest of the fiscal year. I'm a little hesitant about the reduction in debt because of the attractive rates, but it's hard to dislike a company for paying down its interest-bearing debts. The combination of dividends (a 2.20% yield) and share buybacks has made the company attractive to many dividend growth investors, and I think the company fits well there. I would caution investors to remain diversified in their dividend growth portfolio, but the company has a place within the portfolio.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of "outperform" and "underperform" reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from either Yahoo Finance or the SEC database. If either of these sources contained faulty information, it could be incorporated in our analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.