It's pretty clear that United Technologies (NYSE:UTX) has built itself around two principal themes – the increasing urbanization of the world and the increasing accessibility of commercial air travel in emerging markets. While these look like good horses to ride for the long haul, they don't promise great growth every year. In addition, United Technologies still has to prove that it can successfully integrate Goodrich and make this expensive deal a value-creator for the long term.
Sluggish First Quarter Trends
A lot is made of UTX's broad end market, geographical, and economic cycle exposure, but at the end of it all the company isn't doing any better than other industrial conglomerates like General Electric (NYSE:GE), Honeywell (NYSE:HON), Eaton (NYSE:ETN), and Johnson Controls (NYSE:JCI).
Revenue rose a reported 16% this quarter, but organic performance was actually a negative 2% for the quarter and the company did miss the average sell-side estimate by about 3%. Outside of the Sikorsky helicopter business (which was down 7%), the individual businesses weren't too far off the sell-side targets, but there was rather a general sense of malaise through the reported numbers.
To its credit, United Technologies management did earn some of it back through margins. Segment-level profits were pretty much on target (despite the revenue miss), and the company did produce better margins. While reported operating income was up 5%, core operating income was up about 2% and reported segment profits were up about 18%.
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Better Days Seem Like A When, Not If
The organic performance of United Technologies' aerospace business was not great this quarter, but then it wasn't really expected to be. None of the major aerospace companies that have reported thus far had great quarters, with GE's relative outperformance likely due to its particular business mix (more focus on engines, less military, etc.). All told, UTC's aerospace performance was pretty consistent with Honeywell and an overall mediocre aerospace market.
Likewise, there wasn't a lot to love in Otis or CC&S this quarter, as organic growth was weak. Here, too, there was little reason to expect big things. Prior reports, guidance, and warnings from companies like Honeywell, Siemens (NYSE:SI), Johnson Controls (NYSE:JCI), and Kone have made it more than clear that new construction activity is still asleep in North America and Europe and much slower in emerging markets, while retrofit activity has also slowed.
As investors know so well, though, past performance does not guarantee future results. In particular, I think the 24% order growth in Otis is encouraging, as is the 5% order growth in CC&S. Likewise, while I think the business jet and defense markets could be weaker for longer, I believe Boeing (NYSE:BA) and Airbus still intend to deliver those ambitious commercial jet build schedules. Moreover, the company has retrenched around business lines where I believe the company can be competitive for the long-term and enjoy above average global growth.
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Goodrich Certainly Matters
United Technologies clearly took a big swing at the aerospace market when it acquired Goodrich. The deal made sense on many levels (there was relatively little overlap between the two businesses) and has made the company a major go-to vendor in the original equipment and aftermarket segments in virtually every major aerospace segment. What's more, the assumed synergies from the deal still look relatively modest (and certainly achievable) relative to other comparable deals. Still, the deal has to go well from here or United Technologies will find itself looking at a major loss of shareholder value. Although the large Goodrich deal does not mean that the company is done with M&A, it likely does mean that there won't be major moves for some time.
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The Bottom Line
Given the ups and downs of the aerospace market, and the under-appreciated fact that airlines certainly can and will cancel orders if their business erodes, I'm not thrilled about United Technologies' 50%-plus exposure to the industry. That said, the company is clear about what it is, so it's not as though the exposure to aerospace (and the resulting pluses and minuses) comes as a surprise. What's more, nearly 90% of the company's business is targeted at trends (urbanization, greater use of air travel, energy-efficient buildings, etc.) that should deliver above-average long-term global growth.
All of that said, and as is the case with so many industrials today, it seems like the market is already on point here. Even if United Technologies can grow revenue at a mid-single digit rate and grow free cash flow (FCF) more than double that, we're still talking about a company with a fair value under $90. While I do expect UTX's key markets to start picking up, I have to ask just how much of that is already in the shares today.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.