United Technologies: A Rational Investment For The Long Term

| About: United Technologies (UTX)

Summary

United Technologies has great potential for earnings growth in the short term.

Customer trust allows the company to keep its market positions, even in unfavorable conditions.

Higher oil prices will have a positive impact on industrial companies.

United Technologies Corporation's (NYSE:UTX) Q1 2016 earnings report had a dual character. While its operating income remained at the same level as in Q1 2015, its net profit fell from $1.43 billion to $1.19 billion this year. Net sales have increased by 0.3% from $13.320 billion to $13.357 billion, and the main reason for the loss in net income is unfavorable changes in currency exchange rates.

UTC operates in four business segments (Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems) with different areas of business, namely in the aerospace, construction and defense industries. Asset diversification allows UTC to make profits in any geopolitical and economic environment. For example, the company was able to demonstrate satisfactory financial results last quarter due to a 7.7% increase in profits at the Pratt & Whitney division. The increased number of capital repairs in the aircraft industry, in particular, in replacements of jet engines, led to a 19% year-over-year sales growth of commercial air spare parts on the aftermarket.

Other companies showed a drop in sales due to currency devaluation against the US dollar as well as a decrease in global economic activity. Sales of Otis, UTC Climate, Controls & Security and UTC Aerospace Systems decreased by 1.1%, 1.2% and 1.2%, respectively. UTC's operating profit margin decreased by 1%, from 16.4% to 15.4% of sales. It is necessary to take into account the growth of the conglomerate's market capitalization by 1.2%, which can be explained by an increase in capital expenditures (e.g. more capex leads to more sales and cash flows in the long run).

According to market estimates, the company's earnings per share will grow on a quarterly basis.

(Source: Nasdaq)

From Q2 2015 to Q1 2016 the actual quarterly figures have been ahead of projections.

The surge in sales in the aftermarket of air parts is cyclical and temporary, but Pratt & Whitney fully remedied the situation by introducing new commercial engines, the "geared turbofans," in June 2016. It has already received about 7,000 pre-orders, which indicates success of 20 years of research and development. Also, Pratt & Whitney signed a solo contract for the supply of GTF engines for regional jets manufactured by Mitsubishi, Bombardier C-Series, Embraer E170 and E190 / 195, and Irkut MC-21. One contract was signed jointly with GE-Safran for the Airbus 320neo.

According to management, these engines have better-than-expected fuel efficiency and reliability. This may positively contribute to the engines' sales. Based on the fact that the "geared turbofans" represent a new generation of engines, they can significantly reduce operating noise and the amount of fuel used. The advantages of using these engines give grounds to assume that Pratt & Whitney will soon take a leading position in the air propulsion market.

UTC has strong long-term relationships with its customers. This is confirmed by the fact that the company receives 44% of consolidated revenues from maintenance and repair services. The customer loyalty, in our opinion, is based on the high quality of products and services. For example, the Otis division receives 60% of revenues from maintenance and repair services - UTAS - approximately 45%. This may serve as a good point for value investing.

The monetary and fiscal stimuli currently conducted by some countries both in the developed and emerging economies in collaboration with the increase in commodity prices contribute to the growth in real estate prices. This trend is leading to an increase in the profitability of new construction, which, in turn, portends growth in orders and revenues, respectively, for the products of OTIS and UTC Climate, Controls & Security, whose joint adjusted operating profit amounted $1.115 billion (from UTC's consolidated adjusted operating profit of $2.081 billion).

The recent positive dynamics on the oil market serve as a tailwind for UTC. First and foremost, the rise of the oil market is pushing up prices for other commodities, which contributes to an increase in demand for products and services of industrial companies. Remember that their well-being is closely connected with macro factors like the improvement of global economic activity and the increase in global consumption.

The development will be inhibited mainly due to the increase in expenditures for factory relocation, but after the completion, the company will begin to show better results due to the reduction in operating expenses.

In February 2016, there was a scandal about the management's decision to close two Indiana plants of the UTC Climate, Controls & Security segment, which were part of the air-conditioning business. These measures will be carried out in connection with the transfer of the segment's factories to Mexico to enhance their global competitiveness, reduce costs, and increase the return on investment. The procedure, according to management, will begin in 2017 and take three years in total.

Conclusion

A long-term investment in United Technologies Corporation is reasonable because of the company's competitive advantages over its industrial rivals. The company undoubtedly has demonstrated better financial metrics than most of its direct competitors.

Moreover, a rebound in the growth rate of developed economies will definitely serve as a catalyst for sustainable increase in industrial companies' valuations, and United Technologies Corporation will be one of the first in line to receive investors' dollars.

Societe Financiers is an investment research team focused on long-term, long- and short-only ideas. Our research objective is to cover equities in various regions, such as North America, EMEA, Asia, Australia, and Emerging Markets.
Readers should consider whether any advice or recommendation in our research articles is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of investments referred to in our research articles and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.
Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Transaction costs may be significant in option strategies calling for multiple purchase and sales of options such as spreads.

Disclosure: I/we 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.