One of the reasons that conglomerates often used to carry discounts to pure-plays was the fear/belief that management teams struggled to keep a careful over all of the moving parts of the businesses in the stable. In the case of United Technologies (UTX) I can see the point. While UTC looks to be in excellent shape to benefit from the ongoing commercial aviation upswing, I do worry a bit about businesses like Otis and Climate Control.
Sluggish Performance In Q1
United Technologies' first quarter was a mixed bag. Revenue performance was definitely sluggish, but management made a lot of that back with tight operational efficiency.
Revenue dropped 2% as reported (missing the average estimate) due in part to net divestitures, while organic revenue rose 1%. Growth was led by aerospace, as Pratt & Whitney saw 6% growth and Hamilton Sundstrand grew more than 8%. Sikorsky was quite weak (down 15%), while CC&S fell 6% and Otis more or less came in flat.
Below the top line, UTC picked up a little gross margin leverage (though less than half a point), and managed to deliver a 1% operating income increase. Segment operating income was flat, though, as Otis, CC&S, and Pratt & Whitney all reported lower segment margins.
It's Always About The Relatives
United Technologies definitely held its own relative to the likes of Honeywell in the Hamilton Sundstrand business. In the Pratt & Whitney engine business, though, revenue growth did trail GE by 50% and orders were down whereas GE reported increased orders. While P&W had had a good run of share growth, it seems like GE is fighting back and regaining some momentum. Still, with some quality wins in the books I think UTC's commercial engine business is basically fine.
I'm a little less confident about Otis and CC&S, though. Not only was Otis revenue basically flat, but orders were down 9%. That's quite a bit worse than the performance reported from Kone and Schindler. What's more, while UTC may be digesting prior large gains in order growth in Pratt & Whitney, at Otis it's been nearly two years since the company had better orders than Kone and has generally trailed Schindler as well. Over that time, Kone has had average quarterly order growth of 10.7%, Schindler 7%, and Otis 5%.
Turning to CC&S, it's a question of where you look. Management doesn't seem as confident about a non-resi construction/retrofit rebound as Johnson Controls (JCI) or Ingersoll-Rand (IR), but the residential business is looking stronger.
Too Much Focus On Goodrich?
All of the above makes me wonder if management has been a little too attentive to building aerospace (including preparing for the acquisition of Goodrich) at the cost of other divisions.
The Otis business definitely needs better performance; the growth in this market is going to come from emerging markets and I'm not sure the company is as well-positioned as its rivals with a full range of products (and prices) to meet the demand. Elsewhere, I worry that the security business has been cobbled together more than integrated and is losing momentum to Tyco (TYC), Honeywell and Assa Abloy as a result.
Now, there's nothing wrong with management wanting a strong aerospace business. I do believe that builders like Boeing (BA), Airbus, Bombardier, and Embraer (ERJ) are going to be busy for a number of years filling the commercial backlog. I also think the defense business will be lumpy but still basically supportive for growth at UTC. I just worry that management has let other business get a little flabby and complacent in the meanwhile.
The Bottom Line
For all of this criticism, I'm sure UTX longs expect me to fire off a closing blast and suggest investors avoid this stock at all costs. Not so.
I think the problems in Otis and CC&S are fixable, and I also think that the Street has already baked in a fair bit of pessimism regarding the sum total of the conglomerate's performance. With good growth prospects from aerospace in 2012 and 2013, not to mention recoveries in both residential and non-residential construction, I think management will have the "free time" to address the aforementioned issues and get performance back up to scratch.
I would like to see better returns on capital from this business, but I have to also applaud management for only one down year in revenue and free cash flow in the last ten. If management can grow future free cash flow at a 6-7% clip (demanding, but not outrageous), these shares deserve to be in the triple digits and they merit serious consideration hovering here around the 200-day moving average.