Is United Technologies On Top Of Strategy?

| About: United Technologies (UTX)

Summary

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.

P&L

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.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here