What United Technologies Corporation Must Do in 2017

By Lee Samaha Markets Fool.com

It's well known that United Technologies Corporation (NYSE: UTX) is a good value stock, provided the company can get past its earnings headwinds in the next couple of years. To do that, management needs to successfully execute on its near-term plans to secure long-term earnings and cash flow. Let's look at each segment and pick out a key performance marker that investors need to look out for.

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United Technologies' guidance for 2017

Management recently outlined expectations for full-year 2016 EPS in the range of $6.55 to $6.60, leading into EPS in the range of $6.30 to $6.60 for 2017. That marks a decline in overall earnings; moreover, segment earnings are expected to decline by $0.21 to $0.02. In fact, if not for an expected contribution of $0.32 from share buybacks, EPS could even be marginally below $6.

The following table outlines segment expectations:

Segment

Adjusted Operating Profit
(ex-FX, in millions)

Adjusted Operating Profit
(in millions)

Otis

($100) to ($50)

($175) to ($125)

Climate, controls, and security

$150 to $200

$100 to $150

Pratt & Whitney

($325) to ($275)

($200) to ($150)

Aerospace systems

$25 to $75

$50 to $100

Total segment

($250) to ($50)

($225) to ($25)

DATA SOURCE: UNITED TECHNOLOGIES CORPORATION PRESENTATIONS.

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Foreign exchange movements don't make much change overall to the outlook range. Now it's time to look at each segment and pick out a key thing to look for in another transitional year for the company.

Otis

CEO Greg Hayes plans to regain market share by expanding new-equipment volumes to generate future sales of services, which tend to be high-margin. In addition, management is making $75 million worth of strategic investments to "address market coverage issues" and "improve service productivity and service stickiness," according to CFO Akhil Johri.

Given these objectives, the key measure to follow is volume. Management expects a positive contribution from volume of $75 million to $125 million and a further positive contribution of $75 million from productivity improvement. The question is: How does management get to an adjusted operating profit (that is, constant-currency) decline of $100 million to $50 million for 2017?

The answer is in the $175 million reduction from pricing/sales mix and the $75 million made in strategic investments. However, as already noted, these measures are being made to drive future productivity. Equipment volume is the thing to focus on at Otis, because it's the key to future growth.

OTIS INTENDS TO INCREASE EQUIPMENT SALES. IMAGE SOURCE: UNITED TECHNOLOGIES CORPORATION.

Pratt & Whitney

The larger part of an expected decline of $325 million to $275 million is coming from a forecast $350 million hit from the commercial original equipment mix. From this, Johri expects an incremental $300 million reduction from negative engine margin (losses suffered as the new engine ramps up in production) on the Geared Turbo Fan (GTF). Pratt & Whitney's new engine orders are seen as falling behind those ofGeneral Electric Company's LEAP engine in the all-important Airbus A320neo program.

The $300 million is in line with previously announced expectations. Management has also forecast an additional $100 million in negative engine margin in 2018, ultimately leveling off at $1 billion.

Aside from negative engine margin in 2017, the key metric to follow is GTF production. Having planned for 200 in 2016, Pratt & Whitney is on track to deliver only 150 in 2016, and all eyes are on the company's delivering on the 2017 target of 350 to 400, while management strives to reduce the cost per engine.

PRATT & WHITNEY HAS HIGH HOPES FOR ITS GEARED TURBOFAN ENGINE. IMAGE SOURCE: UNITED TECHNOLOGIES CORPORATION.

Aerospace systems

It's a positive that the segment is getting back to earnings growth, but here, too, United Technologies has headwinds to overcome. In short, an unprecedented raft of new aircraft programs such as the Airbus A350 and Boeing 787 and 737 MAX are going into production. That means suppliers such as United Technologies must make new products; the problem is that this creates a margin-mix headwind because it takes time to reduce cost per output on new products while legacy products have higher margin.

Ultimately, management forecasts the commercial original equipment (OE) mix to reduce segment profit by $350 million to $325 million. Cost reductions of $250 million and increases in commercial aftermarket/military sales of $75 million to $100 million will more than offset the decline.

The key metric to follow here is the negative contribution from the commercial OE mix. Will aerospace systems manage to reduce cost per output on newer products more than expected in 2017?

UTC AEROSPACE SYSTEMS SUPPLIES COMPONENTS ON THE AIRBUS A350. IMAGE SOURCE: UNITED TECHNOLOGIES CORPORATION.

Climate, control, and security (CCS)

Toward the end of his presentation, Hayes outlined the need to make investments in the sales force to recapture market share in the CCS segment. In that context, the key indicator to follow here is organic sales growth. The forecast is for low-single-digit organic sales growth, and the opportunity is to try to better that, particularly as the company has new products available in commercial heating, ventilation, and air conditioning.

Looking ahead

Management has work to do in all four segments to get through another transitional year, but if it does so, the company will start to look in much better shape at the end of the year. Negative engine margin at Pratt & Whitney will be seen as peaking in 2018, while the negative sales-mix headwinds should peak in aerospace systems in 2017. Meanwhile, Otis' volume expansion should reap benefits in future years.

All told, successful execution will make the stock look extremely attractive in 2017, and now could be the time to buy in.

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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.