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.
SEE: 5 Earnings Season Investing Tips

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.

SEE: Conglomerates: Risky Proposition?
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.

Related Articles
  1. Investing

    Charles Koch Biography

    Charles de Ganahl Koch is the CEO and co-owner of Koch Industries, an oil and industrial conglomerate that ranks as one of the largest privately held companies in America. While he and his company ...
  2. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Conglomerate

    A company that owns controlling stake in a number of smaller ...
  3. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  4. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  5. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  6. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!