With the economy taking much longer to reach full employment than expected, many investors are rightfully reserved about capital goods. In this article, I will run you through a DCF model on United Technologies (UTX) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Honeywell (HON) and General Electric (GE). I find that the company is fairly valued right now and that GE is the most attractive investment.
First, let's begin with an assumption about the top-line. United finished FY2011 with $58.2B in revenue, which represented a 7.1% gain off of the preceding year. I model growth trending between 8 and 11% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 72.5% of revenue versus 10.9% for SG&A, 3.1% for R&D, and 1.6% for capex. Taxes are estimated at 29% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $85.75. Put differently, the discount to intrinsic value has been nearly closed.
All of this falls within the context of impressive performance:
"UTC closed out a strong 2011. Full year sales were over $58 billion, up 7% from 2010 and 6% organic growth, with all 6 of our businesses growing organically. Earnings per share were $5.49 and that's up 16% year-over-year. And free cash flow was very strong at 113% of net income, with 67% return to shareowners through dividends and share repurchase. And we achieved all of this while continuing to invest for the long term".
From a multiples perspective, my DCF result is reasonable. United trades at a respective 14.7x and 12.1x past and forward earnings versus 25.5x and 11.9x for Honeywell and 15.7x and 11x for GE.
I am most reserved about Honeywell. The multiples are the highest among the three and the low 2.5% dividend yield does not compensate for the 1.4 beta. Consensus estimates for Honeywell's EPS forecast that it will grow by 9.6% to $4.44 in 2012 and then by 12.2% and 13.7% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $4.90, the stock would rise by 15.5%. With much more volatility than the broader market, however, there are stocks with higher upside.
GE is rated near a "strong buy" on the Street, according to NASDAQ. Consensus estimates for the conglomerate's EPS forecast that it will grow by 12.4% to $1.54 in 2012 and then by 14.3% and 18.2% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $1.73, the stock would hit $24.22 for 25.1% upside. GE is a diversified industrials company with a core financial arm. In my view, the synergies from the segment is greater than what the market appreciates. Given the 3.6% dividend yield, GE has excellent risk/reward. Accordingly, I recommend backing the company over Honeywell and United.