Is United Technologies Still Worth Buying?

By Markets Fool.com

With United Technologies (NYSE: UTX) in 2016,the aim is takeshort-term pain to generate long-term gain. The company is in a year of transition in three of its four segments, and if you can ignore the short-term negative impacts, the stock looks like a good value. However, the company needs to execute, so let's look at what's going on and what's in store.

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United Technologies' transitional year

General Electric Company (NYSE: GE) outperformed the S&P 500 in the past couple of years, largely because of the successful execution of its strategy to refocus on the industrial sector while developingnew industrialtechnologies that are set to generate strong long-term recurring revenue for the company. Is United Technologies about to similarly reward investors?

UTX data by YCharts

The following table outlines the key partsof the plan. The company is taking significant action in 2016, not least with a production ramp-up on its geared turbo fan (GTF) engine. (Read more onthe negative engine margin issue and competition with General Electric Company's LEAP engine.)

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Segment Action Intent Short-Term Pain Long-Term Gain
Otis Be more price-competitive in equipment sales Expand unit sales, particularly in China

Lower sales

Expand services revenue because of larger installed base
Pratt & Whitney Ramp up production of new GTF engine

Establish GTF on aircraft platforms

Profits hit because of negative engine margin Reduce cost per engine over time; services revenue from installed base
Aerospace Systems Expand sales of products on newer aircraft platforms Market share Margin hit as parts on newer platforms tend to be, initially, lower margin Recurring revenue from aftermarket; margin improvement as cost per unit production is cut

SOURCE: AUTHOR'S INTERPRETATION OF COMPANY STATEMENTS.

The actions taken are all to ensure long-term growth, and that's why it's a mistake just to look at United Technologies' immediate earnings prospects. Nobody is going to get excited by analyst projections for EPS growth of just 4.7% per annum for the next couple of years: The key is to execute the plan.

Is United Technologies on track?

The following table shows the company's most recent projections for 2016 compared with those at the investor day in March 2016. Current sales expectations are unchanged. However, better profit projections at Otis are offset by a more negative outlook at Pratt & Whitney.

Segment

Original Organic Sales Growth Estimate

Current

Original Operating Profit Change Estimate (in Millions)

Current (in Millions)

Otis

up low single digit

up low single digit

($250) to ($200)

($200) to ($150)

Pratt & Whitney

up low single digit

up low single digit

($50) to $0

($100) to ($50)

Aerospace Systems

up low single digit

up low single digit

($50) to $0

($50) to $0

Climate Controls and Security

up low single digit

up low single digit

$100 to $150

$100 to $150

DATA SOURCE: UNITED TECHNOLOGIES PRESENTATIONS

Overall, the company appears to be on track. Indeed, in the second-quarter earnings presentation, management upgraded 2016 EPS expectations to a range of $6.45 to $6.60 from a previous range of $6.30 to $6.60. Similarly, 2016 sales are now expected to be in the range of $57 billion to $58 billion from a previous range of $56 billion to $58 billion.

Otis and Pratt & Whitney

However, that's not the full picture. Otis' constant currency equipment orders were down 4% in the second quarter but were up 4% on a unit basis -- good, because the aim is to increase the installed base. On the other hand, on the earnings call, VP of Investor Relations Paul Lundstrom mentioned that the $50 million improvement in the full-year operating profit guidance range (see the preceding table) is "based on better-than-expected foreign exchange transaction."

UNITED TECHNOLOGIES NEEDS TO PRODUCE ITS GEARED TURBO FAN ENGINES ON SCHEDULE. IMAGE SOURCE: UNITED TECHNOLOGIES WEBSITE.

Turning to Pratt & Whitney, CEO Gregory Hayes affirmed expectations to build 200 GTF engines in 2016 (60 were built in the first half, with a further 140 expected in the second half). However, there are three reasons it's not plain sailing:

  • Higher negative engine margin, per Lundstrom and Hayes.
  • Additional investments made to support the production ramp-up.
  • Headwinds from lower-than-expected military sales

These headwinds helped result in the cutting of guidance for operating profit in 2016 for Pratt & Whitney.

In addition, Bombardier recently slashed ts delivery guidance for its new Cseries aircraft -- a plane powered solely by the GTF -- citing delays in receiving GTFs from Pratt & Whitney. Moreover, concerns have been raised on deliveries of GTFs for the Airbus A320neo, a platform on which the company competes with General Electric's LEAP.

The bottom line

All told, United Technologies isn't quite executing as planned with regard to the GTF. However, management affirmed that production plans are on track and the company remains cheap compared with its peers.

UTX EV to EBITDA (Forward) data by YCharts

Management still expects 90% to 100% of net income to be converted into free cash flow in 2016. Based on analyst estimates for EPS of $6.58 in 2016, it equates to about $6.25 per share in free cash flow. In other words, around 5.1% of enterprise value (market cap plus net debt) -- and that's not bad for a company in a transitory year. Despite the minor setbacks with the GTF, the stock remains attractive.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.