4 Reasons to Buy UTX
Ankit is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Before heading into 2Q, Investors were worried about the United Technologies Corporation’s (NYSE: UTX) earnings outlook for 2012 because of several trends but especially due to the weak Otis in China and slower commercial aerospace spare parts sales. However, the company reported strong 2Q earnings (EPS of $1.62 vs. the consensus estimates of $1.42) and the stock price has gained over 8% thereafter. Going forward, I believe United Technologies will continue this performance and have ample opportunities in 2013 to use strong cash flow to drive shareholder value through buybacks, dividends and further acquisitions as I expect the company to get $3 billion in after-tax divestiture, over $1.8 billion free cash flow generation in 2H12 , and over $4.8 billion in FY13. The following are some additional positives that make me bullish for this stock.
Positive Synergies of Goodrich acquisition
United Technologies closed the Goodrich acquisition at the end of July and currently expects the deal to be $0.50-$0.55 accretive to 2013 earnings (hefty YoY swing of $0.80). However, I expect upside to this number given the original $400 million in annual run-rate synergies has already been identified. Additionally, there are following further opportunities with respect to technology synergies:-
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Control systems from Goodrich can extend the life of the Geared turbofan (GTF).
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Composite technology on nacelles at Goodrich can be used at Pratt & Whitney.
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Product procurement volume negotiations as Goodrich add $3 billion to United Technologies’ existing $6 billion).
United Technologies will host at least two webcasts in September in addition to an analyst event at Pratt & Whitney Canada’s facility. I am looking forward to hear updated estimates at these meetings. Given expected favorable swings in intangibles, synergies, and accounting conformity, I expect Goodrich EPS contribution to increase by ~$0.12 in 2014.
Huge Aftermarket Opportunities in China
United Technologies' stronger results of Otis in 2Q (as compared to 1Q) can be attributed to the recovery of Otis specifically in China. I am optimistic that Otis will continue to recover in China in the coming quarters. Also, I believe there is significant opportunity to increase aftermarket business in China in near term as the aftermarket comprising only 7% of the Chinese market (as compared to 60% for Otis overall).
Expectations from Pratt & Whitney in FY13
In 2Q, commercial aerospace spares orders at Pratt & Whitney declined 15% and revenue of $3.45billion grew 5% YoY. I am optimistic about P&W recovery in FY13 given recent recovery trend at Pratt Canada, continuing lift in large commercial engine OE, some decline in R&D from 2012’s peak and a full year of International Aero Engines (IAE). I believe Pratt & Whitney’s new PurePower GTF engines will ramp up aggressively in late 2013 and throughout next 2-3 years. Therefore, long term growth prospects of United Technologies are intact despite poor 2Q results from P&W.
Low Valuation
United Technologies has numerous competitors, though most competitors are specialized to only one business field. For example; General Electric (NYSE: GE) competes with Pratt & Whitney in producing airplane engines, and Honeywell (NYSE: HON) is a large conglomerate that competes with United Technologies in both the aerospace and building supply markets. The following table summarizes the forward PE and expected EPS growth next year of United Technologies, GE and Honeywell:
|
Company |
Expected EPS Growth (in FY13) |
Forward PE |
|
Honeywell |
11% |
11.89 |
|
GE |
12.3% |
12.42 |
|
United Technologies |
19.2% |
12.4 |
GE and Honeywell both are trading with a forward PE comparable to United Technologies’ while estimated EPS growth of United Technologies in FY13 is relatively much higher (United technologies’ 19.2% vs 11% and 12.3% of GE and Honeywell respectively). Therefore, the company appears to be undervalued on a relative basis.
United Technologies’ conservative balance sheet and strong FCF conversion allow for continued share buybacks and M&A; providing a possibility of EPS upside. However, in the near term, the company’s stocks are volatile due to macro slowing. Further, Goodrich close is also likely to increase near-term dilution. We believe that UTX, in beginning of 2013, will be having compelling late-cycle appeal. Thus, I recommend buying this stock and suggest investors to wait for better entry point.
ankitagrawal has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
