This Company’s Future Is up in the Air

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When a multi-billion dollar company makes a multi-billion dollar bet on an industry, that bet better pay off. When that same company is one of the most well-known companies in the world, the risk is even bigger. This is why with United Technologies (NYSE: UTX) bet on the airline industry through their acquisition of Goodrich and existing Pratt & Whitney business, the company is betting big. If this bet pays off, shareholders will benefit greatly; if this doesn’t pay off, billions of dollars could be wasted.

Everyone Wants a Piece of This Pie

It shouldn’t be a shock that the airline industry is expected to grow significantly over the next few years. Airlines struggled tremendously during the Great Recession, and companies decided to wait on heavy investments. Now that the economy is on the mend and airlines are investing in a more efficient fleet, Boeing (NYSE: BA) would seem to be the obvious choice for investors.

While it’s true that Boeing should do well in the next several years, the company hasn’t exactly been generous in rewarding shareholders. Though the company generated roughly $9.9 billion in free cash flow over the last three years, only about $3.8 billion was spent on share repurchases, and the company actually issued shares on a net basis.

When an obvious leader in an industry doesn’t seem like the best option, investors need to look elsewhere. Not only could United Technologies be a good choice, but companies like General Electric (NYSE: GE) could also make some sense. If investors want to bet on a continued economic recovery, they might also choose to invest in a player in the auto industry. Auto companies have struggled in the same way the airlines have, and Johnson Controls (NYSE: JCI) is not only a direct competitor to United Technologies, but also has a huge part in the auto cycle recovery.

With all of these solid choices available to investors, choosing the right one requires some digging into each company’s recent results and financials. While all of these companies might offer some positives for investors, there are at least four reasons to believe that United Technologies could be the best investment of the group.

Strength Upon Strength

When researching United Technologies, I realized that the company not only should be positioned for strong growth, but they are delivering on this potential as well. One of the first ways investors might measure United Technologies' potential is by looking at what analysts expect from earnings growth.

Over the next few years, the average analyst expects earnings growth of 13.5%, which is second only to Boeing at 13.9%. By comparison, Johnson Controls' EPS growth is expected to come in at 11.73%, and General Electric is expected to grow by 10.87%. Considering that United Technologies has a diversified business and is expected to grow earnings almost as quickly as the more focused Boeing, this is pretty impressive.

The second area of strength for the company is that they are exhibiting strong revenue growth in both the Pratt & Whitney and UTC Aerospace Systems businesses. With Pratt & Whitney showing revenue growth of 11.48% and UTC Aerospace posting triple-digit revenue growth, it just shows that United Technologies is taking advantage of the growth in the airline and aerospace industry.

A third reason for investors to consider United Tech is that the company carries a strong operating margin. This shows that the company either has good pricing power, good expense controls, or both. In fact, of the group the only company with a stronger operating margin is General Electric at 19.27%. United Technologies comes in second at 13.93%, which easily beats Boeing at 8.09% and Johnson Controls at 3%.

The fourth reason United Technologies should be on every investor's Watchlist is that the company’s growth in earnings and cash flow is even more impressive when you consider their low payout ratio. Of their peers, United Technologies actually has the lowest core free cash flow (net income + depreciation – capital expenditures) payout ratio.

In the current quarter, United Tech. paid 30.98% of their free cash flow in dividends. By comparison, Boeing paid 36.19%, Johnson Controls' payout ratio was actually 146%, and General Electric paid out 90.42%. When you realize that United Tech is growing fast, generating cash flow, and has the lowest payout ratio, there is a lot of potential for investors to benefit as these trends continue.

A Combination That Is Hard to Beat

If you look at United Technologies overall, the investment case is pretty hard to contest. The company has the second fastest expected earnings growth of the group. As proof that the company should turn earnings growth into cash flow, the company’s strong operating cash flow growth just proves that management knows how to generate cash to reward shareholders.

When you combine United Technologies’ strong potential, good cash flow, and low payout ratio, the stock already looks like a good value. Combining these positive traits with a stock that trades for a P/E of about 15, which is similar to its peers, the stock looks even better. This company’s future is up in the air, and that’s actually a good thing.

With the U.S. relying on the rest of the world for such a large percentage of our goods, many investors are ready for the end of the "made in China" era. Well, it may be here. Read all about the biggest industry disrupters since the personal computer in 3 Stocks to Own for the New Industrial Revolution. Just click here to learn more.

 


Chad Henage owns shares of General Electric Company. The Motley Fool owns shares of General Electric Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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