Is United Technologies On Top Of Strategy?

| About: United Technologies (UTX)


UTX's third-quarter results are likely to be welcomed by investors, but I still doubt management will be able to deliver long-term value.

Its P&L shows that revenues are falling at a faster pace than costs, and working capital management is another critical area.

There are better options in the market, such as Honeywell, for example.

Today's third-quarter results announced by United Technologies (NYSE: UTX) do not move the needle, in my view, and I also wonder whether its new $12bn share repurchase plan makes any sense at this point in the business cycle.

That said, initial reaction to its trading update will likely be good -- at the time of writing, prices in the future market indicated that UTX could outperform the main indexes by about two percentage points in early trade.


The company's revenues have dropped 2.6% to $41.8bn in the nine months ended 30 September, but the decline accelerated in Q3, when sales were down 5.6% to $13.8bn year on year.

Its cost base is shrinking, but trends aren't particularly appealing, either.

Consider that its 'total costs and expenses" line, which includes COGS, SG&A and R&D, fell 2.3% and 4.8% in the nine months ended 30 September and in Q3, respectively - this means revenues are falling at a faster pace than costs.

One cost that is mildly rising is that associated to interest expenses, up from $615m to $618m in the nine months ended 30p September. I wonder why management has not decided to redeem some debt instead of launching a stock buyback.

Confidence Boost

True, net leverage is manageable, the free cash flow yield is north of 3%, credit conditions are loose, and a base-case scenario suggests that any rise in the cost of debt could be minimal, but there remains a doubt that lower net leverage (at 1.4 times on a forward basis) could boost investors' confidence at a time when revenues are under pressure, and virtually all units -- excluding UTC Aerospace Systems -- have experienced a drop in profitability in the first nine months of trade.

Elsewhere, a positive sign is represented by lower restructuring costs across all divisions with the exception of UTC Aerospace Systems, its second-largest revenue contributor at $10.6bn.

Quarterly earnings per share of $1.61 are down 16% year on year and down 9.1% to $4.76 for the nine months ended 30p September, but today's results confirm that United will likely meet EPS estimates in 2015.

However, I doubt that's good enough to attract investors en masse - its forward P/E multiple is over 14 times, and there are better options in the industrial world.

Finally, with regard to UTC Climate, Controls & Security, its largest division, the group booked "approximately $126 million gain as a result of a fair value adjustment related to the acquisition of a controlling interest in a joint venture investment," which compares with $254m of one-off gains one year earlier.

Balance Sheet & Cash Flow

Inventories surged 10% to $8.4bn in the nine months ended 30 September, and that rise represents the biggest change in working capital for Q3. It contributed to push down its operating cash flow to $1bn from $2bn over the same period in 2014.

So far this year, UTX's operating cash flow has dropped to $4bn from $5bn in 2014. Dividends are mildly rising but stock buybacks were up 135% to $1bn in Q3, while they surged to $4bn (+263% year on year) in the nine months ended 30 September.

Its stock has fallen almost 20% year to date, but its capital deployment strategy won't change much in future.

"Sikorsky sale expected to close in Q4 2015; $6 billion in net cash proceeds to be used for share repurchases," UTX said -- adding that the board had authorized a $12bn share repurchase plan.

My advice is to focus on operational improvement rather than on unrealized capital gains stemming from stock buybacks. Based on all these elements, I'd rather hold a long position in Honeywell (NYSE: HON).

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.

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