Not unlike Honeywell (NYSE:HON) and General Electric (NYSE:GE), United Technologies (NYSE:UTX) has built its business to take advantage of emerging growth cycles in commercial aviation, urbanization, and energy efficiency. Weak construction activity and share losses have limited the growth at Otis, Carrier, and Fire & Security, but the company's aviation business seems to doing relatively well and I believe there's further upside in all of these businesses. My question with UTX, though, is how much margin and cash flow leverage is waiting to emerge, as these shares seem fairly rich without some significant improvements along those lines.
Defense Weighs, But Commercial Aviation Is Doing Better
Although aerospace is one of the growthier areas of the industrial sector today, it wasn't enough to pull United Technologies up to meaningful organic growth. While reported revenue rose 16%, organic revenue growth was flat and the company missed sell-side expectations by more than 2%, largely on weaker defense-related sales.
Margins were mixed. Although the gross margin was not impressive (down 30bp and below expectations), operating income rose about 13% on a “core” basis and the company's margins were about a point higher than most analysts had projected. 
By segment, Pratt & Whitney was up about 5% and Aero Systems revenue was up more than 164% on a reported basis (boosted by the acquisition), while Sikorsky was down about 3%. These results were about 2% to 5% below expectation, and the major sources of the revenue underperformance, as military/defense fell off more than expected. That slots UTX between Honeywell and General Electric, as the former seemed to be significantly impacted by lower defense revenue as well.
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The CCS business was not particularly strong either (down about 1%), though, which is surprising given how Honeywell and Ingersoll-Rand (NYSE:IR) fared, though it's not out of line with Johnson Controls (NYSE:JCI). Relative to Kone, UTX's Otis results (up 4% versus up 14%) weren't very impressive and it looks like the company continues to cede share.
The Plan Sounds Good, But Execution Will Be Everything
In theory, UTX is addressing some very attractive markets with above-average growth potential. Growing demand for air travel in emerging markets ought to fuel a very strong commercial aviation cycle, and UTX is now a major supplier for both Boeing (NYSE:BA) and Airbus. What's more, the increased urbanization of emerging markets and growing need for better energy efficiency across the globe ought to be supportive for Otis and the CCS segment.

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The question is whether UTX can and will make the most of this opportunity. I'm frankly not all that worried about the aviation side of things, as though I think UTX overpaid for Goodrich, I think the growth and margins will ultimately prove worthwhile.

I'm a little less confident in the other businesses. The order growth at Otis looked impressive this quarter (up 22%), but the cynic in me can't help but say “yes, but look at the base it's growing from”. Likewise, I wonder if all of the focus on aviation has led to Otis and CCS suffering from some comparative neglect. With that, I think it may be harder for management to achieve the sort of operating margin and cash flow generation levels it will take to really drive the stock from here.
The Bottom Line
I'm expecting long-term free cash flow growth of 12% from United Technologies (or 7% adjusting for the acquisition), which puts in the upper tier of large cap industrial growth stories. Even with that, though, an investor has to be wiling to ignore the company's sizable debt load for that cash flow to translate into an appealing price target today. I don't believe in ignoring debt, and therefore I think UTX is going to have to achieve some pretty impressive margin improvements for the stock to outperform long term – and with Boeing squeezing suppliers and Otis/CCS looking less competitive, I have my doubts about that.
As it is, if I had to buy a potentially overpriced industrial with aviation exposure, I'd buy Honeywell and General Electric actually still looks undervalued on its own merits. Accordingly, while I understand that investors want stocks with above-average leverage to aviation, I think UTX is already richly valued on that basis.

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