United Technologies (NYSE:UTX) announced in September 2011 that it was going to acquire Goodrich, a global supplier of landing gear, airplane brakes and an assortment of aircraft equipment, for a staggering $18.4 billion in what was to be the largest deal ever in the history of the aerospace industry. Investors were wary of the fact that United Technologies was putting too many marbles on the deal by relying heavily on debt financing. The company's shares tanked 9% the day following the announcement.
But now there is growing evidence that the Goodrich acquisition was actually a sound idea. About two years later, the Goodrich bet seems to be in the money and United Technology CEO Louis Chenevert can breathe a little easier. The deal has given the firm important new items that it can sell to its global aerospace customers, and helped it to rise to an imposing perch in the industry. United Technology can now comfortably supply approximately 65% -70% of the parts used in a commercial airliner. That's close to twice what rivals General Electric (NYSE:GE) with 40% or Honeywell (NYSE:HON) with 35% can currently manage. That kind of breadth gives United Technologies not only cross-selling opportunities, but also helps it create integrated parts that weigh substantially less; a huge plus in the aircraft industry. Customers doing business with United Technologies now have a one-stop shop instead of having to visit ten different suppliers.
Substantial cost savings
The company's management recently said that it expected annual cost savings that come from combining Goodrich with the company's other existing businesses to hit $500 million by 2016. That's a considerable improvement from the 2012 figure of $63 million. The cost savings come from combining staffing, procurement and manufacturing plants. Goodrich is expected to add about $0.55 to United Technologies' expected EPS of $6.11 for 2013.
But perhaps an even bigger benefit for the firm is its broader sales platform. When the sales people call on companies such as Boeing (NYSE:BA) or Embraer (NYSE:ERJ), they can discuss about landing gear, thrust reversers or even aircraft wheels in addition to the company's engines and electrical systems. In January this year, Brazilian aircraft manufacturer Embraer chose United Technologies' Pratt and Whitney division as its sole supplier of the second-generation E-Jet engines which are scheduled to enter service some time in 2018. GE was Embraer supplier of first-generation jet engines. In March, Embraer sweetened the deal even further by selecting United Technologies as the sole supplier of its aircraft wheels and carbon brakes.
United Technologies' global businesses are on the rebound, and are helping the firm to steadily gain momentum after last year's flat earnings and organic sales. Otis, the world's largest elevator manufacturer and one of United Technologies' most important business segments, seems to have recovered from its China stumbles in early 2012. The company had mis-timed a price hike on its Otis elevators in China that coincided with the cooling off of the Chinese economy. In July 2011, tragedy struck when an escalator malfunctioned in a Beijing metro station killing one person and injuring scores more. Revenues from its escalator division fell 3% while operating margins fell from 22.6% in 2011 to 20.8% last year. 60% of United Technologies' revenues come from overseas, so any weaknesses there are keenly felt by the company.
The fourth-quarter of 2012 marked an important turnaround in the segment's Chinese business. Sales jumped 17%. Since then, Otis has been finding good business in small Chinese cities away from the Coast. CEO Chenevert attributes this to rapid rural-urban migration.
Revenues are expected to rise 11% to $64 billion this year. The stock yields a respectable 2.3% with expected EPS for 2013 projected to rise 12% -15%, to $6 -$6.15. The much-publicized effects of sequestration seem to be overhyped and United Technologies expects the negative effects on EPS to be just $0.10. Trefis Analysts have a $116 PT for United Technologies, representing a potential 4% upside potential to the current price. The Street also recommends it as a ''Buy.''
Geared turbofan project bursting with promise
One of Chenevert's biggest achievements so far since his appointment as United Technologies CEO in 2008 is the PW1000G engines project, aka geared turbofan engines. This aircraft engine differs from its forerunners in that its fan spins much slower than the conventional low-pressure compressor and turbine, thus creating more thrust. Even more importantly, the engine burns 15% less fuel than conventional ones, has much lower carbon emissions, is quieter and lighter- all of which are sweet music to airline executives.
Embraer is one of the five aircraft engine manufacturers that have chosen the geared turbofan engine. Bombardier also wants it for its CS 100s. United Technologies estimates that the geared turbofan will generate not less than $400 billion for the company over its lifetime. That figure includes sales and the after-market business including maintenance and spare parts. Aircraft engines typically last about 30 years.
The industrial sector seems to be recovering faster than the rest of the economy. This can be attributed to businesses accelerating capital spending on machinery that had been put on hold during the recession.
General Electric is Industrials Select SPDR ETF's largest holding. Although a lot of GE's businesses are in the industrial sector, the company's GE Finance arm is too large for the company to be classified as a pure-play industrial. GE derived a good 44% of its 2012 revenues from its Finance arm, and 33% of its profits. GE is considering spinning off its Consumer Finance arm in 2014 and refocusing on its core industrial line.
Although GE shares have generally lagged the industrial sector for more than a decade, Barrons estimates that the stock might jump more than 30% in the coming two years with a 3.2% dividend yield. GE CEO Jeffrey Immelt says that the company has the largest exposure to emerging markets amongst the industrials, and a huge backlog of new businesses worth $233 billion. That's about 1.5 times the company's annual revenues.
Honeywell is the World's largest maker of small-jets, avionics and climate & process control equipment. The company has consistently paid out dividends since 1887. Honeywell hiked its dividend for the fourth time in three years from $0.41 to $0.45. Standard and Poor rates Honeywell as a ''Buy,'' and believes the company's focus on cost controls places it in a good position to leverage rising volumes amid a recovering global economy. The company's CEO David Cote has been credited with masterfully remodeling a hodge-podge of money-losing businesses into a profitable technology and manufacturing leader.
Although many investments in the U.S. today carry a Washington risk, United Technologies looks like a good bet for a decent likelihood of double-digits earnings growth in the next few years supported by new and rebounding businesses, solid dividends and share buybacks. That's about as much as any shareholder could ask for.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Syncopy Research is a team of financial analysts. This article was written by Alex Kimani, the firm’s senior analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in the article.