Published December 30th, 2016 by Bob Ciura
United Technologies (UTX) is a diversified global industrial. It has strong brands, and a highly profitable business model.
In addition, United Technologies generates strong cash flow, which it uses to reward shareholders with rising dividends.
As a result, the stock receives a high score using the 8 Rules of Dividend Investing.
It is also a Dividend Achiever. You can see the entire list of all 273 Dividend Achievers here.
The company has paid a dividend on its common stock each year since 1936.
With a 2.6% dividend yield, solid dividend growth, and a cheap valuation, United Technologies could be a winning stock pick for 2017.
United Technologies is an industrial manufacturer. Its customers are in the commercial aerospace, defense, and building industries.
It operates in four segments, which are roughly equal in size:
Source: Goldman Sachs Industrial Conference, page 1
The Climate, Controls, and Security business provides solutions for safer and smarter buildings. Its key brands include Carrier heating, air conditioning, and refrigeration, as well as Kidde and Chubb fire safety products.
Pratt & Whitney designs and manufactures aircraft propulsion products, including jet engines.
Meanwhile, the Aerospace Systems segment supplies components and systems for commercial, military and space aircraft.
Lastly, Otis is the world’s leading manufacturer of elevators, escalators, and moving walkways (hence the pun in the title of this article).
Business conditions are challenging for United Technologies right now. This year, the company has had to deal with elevated geopolitical and global economic risks.
The strong U.S. dollar, Brexit vote, and slowing economic growth in the emerging markets have all weighed on United Technologies. The company generates 62% of its annual revenue from outside the U.S.
And yet, the company has continued to perform very well, despite the higher level of economic uncertainty.
Total revenue and adjusted earnings-per-share from continuing operations increased 1.9% and 5.7%, respectively, through the first nine months of 2016.
Last quarter, United Technologies’ organic revenue increased 5% year over year.
Source: 3Q Earnings Presentation, page 5
This demonstrates that the core business continues to grow, even though net sales were reduced from currency fluctuations.
The best-performing segment for United Technologies is its Pratt & Whitney division, which has seen strong growth due to improving commercial and military aircraft sales.
Source: 3Q Earnings Presentation, page 8
Pratt & Whitney is expected to remain a growth area for the company for the next several years.
United Technologies expects growth to pick up through the end of the decade. The company forecasts strong growth rates across its core business units, particularly for the Pratt & Whitney business.
Source: Goldman Sachs Industrial Conference, page 1
United Technologies is very successful at generating cash flow. Free cash flow rose 16% through the first nine months of 2016.
Such strong growth in free cash flow will fuel continued dividend growth moving forward.
Lastly, United Technologies aggressively repurchases its own stock, which will boost earnings growth. The company utilized $10 billion for share repurchases in 2015.
Going forward, United Technologies intends to return $22 billion in cash to shareholders from 2015-2017. These cash returns will help magnify investor returns.
Competitive Advantages & Recession Performance
United Technologies’ most important competitive advantage is its intellectual property. The company invests significant resources in R&D to fuel product innovation.
Source: Morgan Stanley 4th Annual Laguna Conference, page 5
The billions of dollars United Technologies allocates to R&D each year is helping the company to develop next-generation technology across its business segments.
The company also benefits from scale. It has a $91 billion market cap. Its massive size allows it to cut costs opportunistically to boost margins.
United Technologies’ overall SG&A expenses comprise 9.7% of sales, which the company contends is the lowest in its industrial peer group.
Investors should keep in mind that United Technologies is not a recession-resistant business model. As an industrial manufacturer, its earnings are closely tied to the health of the global economy.
United Technologies’ earnings-per-share through the Great Recession are shown below:
- 2007 earnings-per-share of $4.27
- 2008 earnings-per-share of $4.90 (15% increase)
- 2009 earnings-per-share of $4.12 (16% decrease)
- 2010 earnings-per-share of $4.74 (15% increase)
The recession took a steep toll on United Technologies’ bottom line in 2009. But the good news is that this proved to be a blip on the radar.
Thanks to its scale, the company can quickly cut costs to remain profitable. Earnings-per-share quickly recovered in 2010 and beyond.
Valuation & Expected Total Returns
In addition to its dividend growth, United Technologies stock is a great value play as well. The stock trades for a price-to-earnings ratio of just 12. It is valued at less than half the S&P 500 Index, which has a price-to-earnings ratio of 26.
Even a modest expansion of the valuation multiple could yield significant returns. For example, since 2000 the stock has held an average price-to-earnings ratio of 15.
If the stock moved up to a price-to-earnings ratio of 15, it would generate a 25% forward return just from multiple expansion.
Moreover, future returns will be augmented by earnings growth and dividends. Based on management’s long-term forecasts, a reasonable forecast of expected returns could be:
- 3%-5% organic revenue growth
- 1% revenue growth from acquisitions
- 1% margin expansion
- 1% share repurchases
- 2.6% dividend yield
Based on this, I expect United Technologies to generate approximately 8.6%-10.6% annual returns, plus any expansion of the price-to-earnings ratio.
Investors can also expect United Technologies to continue its streak of dividend growth. The company has current annualized dividend of $2.64 per share.
Its forward dividend represents just 30% of the company’s trailing-12 month earnings-per-share. This is a very modest dividend payout ratio that leaves plenty of room for continued dividend increases on an annual basis.
United Technologies is a stock that should appeal to nearly all investor types. It is a growing company, pays an above-average dividend yield, and grows the dividend each year.
In addition, the stock is cheap, and there is room for expansion of the price-to-earnings multiple as its growth strategies materialize.
As a result, United Technologies could be a rewarding stock pick for growth, income, and value investors. The company ranks highly using The 8 Rules of Dividend Investing thanks to its low valuation, above average yield, and solid growth prospects.