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United Technologies Is Undervalued Despite 12.5% Total Return Potential


United Technologies (UTX) has paid increasing dividends for 45 years. The company has compounded investor wealth at 13.7% a year (including dividends) over the last 25 years.

United Technologies is one of the largest publicly traded diversified industrial goods manufacturers in the world. The company was founded in 1934 and has grown to reach a market cap of nearly $90 billion.

United Technologies Business Overview

The company operates in 5 segments. Each segment is listed below along with the percentage of total operating profits produced for United Technologies in fiscal 2014:

Otis is the world’s largest elevator and escalator manufacturing, installation, and service company.

UTC Climate, Controls, & Security is the leading provider of HVAC and refrigeration solutions. The segment owns the Carrier and Kiddie brands, among others.

Pratt & Whitney is one of the world’s largest suppliers of aircraft engines for both the commercial and military markets.

UTC Aerospace Systems provides advanced aerospace products and aftermarket service solutions for aircraft manufacturers, airlines, military, space, and undersea markets.

Sikorsky is one of the world’s largest helicopter manufacturers. The segment’s margins and operating profits were down significantly in 2014 versus 2013. United Technologies recently announced it would sell its Sikorsky division to Lockheed Martin for $9 billion. The company’s management will use funds the money from the sale for share repurchases.

Recent Weakness & Wall Street Woes

Wall Street did not take kindly to United Technologies second quarter earnings and announcement of the Sikorsky divestiture. The company’s stock declined 7.1% in one day. The decline was due to the Sikorsky divestiture and news that both the Otis and UTC Aerospace segments’ profits are expected to be lower than management previously anticipated.

Is The Company’s Debt Load Sustainable?

In addition to its recent weakness, United Technology also carries $22.4 billion in debt on its balance sheet versus $5.9 billion in cash. In 2014, the company had total profits of $6.6 billion. While United Technologies does have a large debt load, the company has an average interest rate on debt of around 4%. This translates into under $900 million in interest payments a year – not overly concerning given the company’s highly profitable operations.

If United Technologies were to see earnings fall drastically during recessions, the company’s debt load would be worrisome. Fortunately, United Technologies tends to perform well during recessions. The company saw earnings-per-share fall just 15.9% during the worst of the Great Recession. Click here to see other businesses that performed well during the Great Recession.

United Technologies’ contracts with military and aerospace customers help to insulate it from recessions. The company’s relatively stable earnings over a wide range of economic conditions make United Technologies’ debt load sustainable.

Competitive Advantage, Growth, & Total Returns

United Technologies is one of the largest diversified manufacturers in the world. The company’s competitive advantage comes from a mix of its size and scale combined with lean manufacturing, technological know-how, and existing contracts and relationships with large government customers.

The company invests in its employees as well. United Technologies’ employee scholarship program has allowed employees to earn nearly 37,000 degrees since 1996. The company tries to provide a quality experience to all its stakeholders – employees, shareholders, and customers.

United Technologies’ employees speak well of the company and the synergies generated between segments. This comment on Seeking Alpha from a former employee (quoted below) shows the reality of the synergies between divisions at United Technologies:

“As a former employee (and still a shareholder) of UTX who worked in both segments for over 15 years each I can attest in the great synergy between the two [referring to aerospace and building]. Engineers, production, quality, and financial staff regularly collaborated on projects.”

United Technologies’ competitive advantages have driven 7.4% earnings-per-share growth a year over the last decade. Despite temporary weakness, management is targeting 10%+ earnings-per-share growth through a mix of organic growth, share repurchases, margin expansion, and acquisitions.

United Technologies will likely grow closer to its historical growth rate than management’s expectations. I expect earnings-per-share growth of 7% to 10% a year over the next several years. This growth, combined with the company’s ~2.5% dividend yield gives investors expected total returns of 9.5% to 12.5% a year going forward.

Valuation & Final Thoughts

Recent pessimism surrounding United Technologies has driven down the share price. The company is currently trading for a price-to-earnings ratio of just 14.4. United Technologies has traded for a price-to-earnings ratio above 16 for much of the past 2 years.

Wall Street may not have been fond of the Sikorsky divestiture, but the move should be very beneficial for shareholders. United Technologies’ management will repurchase shares with the proceeds from the Sikorsky divestiture. The deal is expected to close in the late 4th quarter of 2015 or early first quarter of 2016.

If United Technologies continues to trade for such a low price-to-earnings multiple through the Sikorsky divestiture, shareholders will benefit. Management will be able to repurchase a large block of shares – about 9% of the entire company – below fair value. Share repurchases done when a stock is trading below fair value are very accretive to shareholder value.

United Technologies currently has a dividend yield of 2.6%. The company has a long history of rewarding shareholders with increasing dividends and rising earnings-per-share. United Technologies ranks highly using The 8 Rules of Dividend Investing thanks to its solid scores for stability, growth, and yield. The company makes an excellent addition to the portfolio of long-term dividend growth investors.



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