Published June 20th, 2016 by Arie Goren
On August 4th, 2015, Sure Dividend published an article on called: “United Technologies Is Undervalued Despite 12.5% Total Return Potential“.
Since that time, the company’s stock is virtually flat.
Source: Google Finance
United Technologies was undervalued and had excellent total return prospects 10 months ago. It still does today. In fact, the company is currently ranked as a Top 10 Dividend Stock using The 8 Rules of Dividend Investing.
The company is generating strong free cash flow, and it raises its dividend payment year after year.
This article takes a detailed look at the investment prospect of United Technologies.
United Technologies Overview
United Technologies is a global leader in the building systems and aerospace industries. The company conducts business through the following segments: Otis; UTC Climate, Controls & Security; Pratt & Whitney; UTC Aerospace Systems. United Technologies was founded in 1934, and its headquarters is in Farmington, Connecticut.
Latest Quarter Results
On April 27, United Technologies reported its first-quarter 2016 financial results, which beat adjusted earnings-per-share expectations by $0.08 (5.8%).
Sales rose to $13.36 billion from $13.32 billion in the same quarter a year ago, also ahead of the consensus of $13.20 billion.
The company has shown earnings-per-share surprise in three of its last four quarters, as shown in the table below.
Source: Yahoo Finance
In the report, Gregory Hayes, UTC President and Chief Executive Officer, said:
“We are off to a solid start in 2016. UTC delivered strong operational performance in the first quarter with organic sales growth of 2 percent. We are also making progress on our strategic priorities, particularly our ability to invest in innovation as we continue to focus on structural cost reduction.”
According to the company, despite a slow-growth global macro environment, it remains confident in its full-year 2016 earnings outlook of $6.30 to $6.60 per share. UTC reiterated its 2016 outlook and continues to anticipate:
Key Growth Drivers
I see healthy growth prospects for the United Technologies. The company maintains a leading position in some key global industries, and it poised to benefit from population growth and the expansion of the middle class in developing markets.
The average annual estimated earnings-per-share growth for the next five years is above-average at 9.1%.
Source: Slide Presentation
Pratt & Whitney net sales in the recent quarter of $3,588 million accounted for 26.5% of the total segments’ net sales. The segment revenue rose an impressive 8% organically year-over-year.
Pratt & Whitney is a leading supplier of aircraft engines. It produces families of engines for wide and narrow-body and large regional aircraft in the commercial market and fighter and transport aircraft in the military market and provides maintenance, repair and overhaul and other support services.
United Technologies expects more than 10% annual average organic sales growth for the segment in the next five years, as shown in the chart below.
For the United Technologies Aerospace Systems, the company expects an annual average organic sales growth of 5% to 7%, and for its Climate, Controls & Security segment, UTX forecasts an annual organic sales growth of 4% to 5%. Otis, the world’s largest maker of elevators and escalators, is expected to grow its organic sales also by 4% to 5%.
Acquisitions and Divestitures
United Technologies is continually improving its business through acquisitions and divestitures. In the fourth quarter of 2015, it sold its slow-growing Sikorsky unit to Lockheed Martin for $9 billion, including an after-tax gain of $3.4 billion. The company has set aside $1-$2 billion for acquisitions in 2016.
During the first quarter of 2016, Honeywell (HON) was trying aggressively to acquire United Technologies by offering $108 per share, or $90 billion. United Technologies rejected the offer considering it grossly undervalued. CEO Gregory Hayes explained:
“Notwithstanding the significant regulatory challenges and customer concerns, Honeywell’s proposal grossly undervalues UTC and overstates potential synergies. Effectively Honeywell’s proposal is a leveraged buyout of UTC using UTC’s own strong balance sheet. Putting aside the insurmountable regulatory risks, the proposal is not an attractive deal for UTC’s shareholders and does not reflect UTC’s strong long term outlook.”
Honeywell had argued that the deal could have generated synergies of $72 billion, and it may come back to the table at some point in the future.
Dividends and Share Repurchases
United Technologies has paid cash dividend on its common stock every year since 1936. In April, UTX raised its quarterly dividend by 3% to $0.66, or $2.64 annually. The forward annual dividend yield is at 2.6%, and the payout ratio is at 56%.
The annual rate of dividend growth over the past three years at 8.0%, over the past five years was at 8.5%, and over the last ten years was high at 11.3%. United Technologies has a long history of dividend growth. In fact, the company is a Dividend Achiever.
Source: company’s reports *assuming same dividend rate for the year
The company is accelerating its repurchase program; it anticipates share buybacks of $3 billion in 2016, beyond the repurchases that will be completed in 2016 under the previously announced $6 billion program. UTX also plans to buy back $18 billion of stock in 2016-2017. At the end of the first quarter of 2016, shares outstanding were down 8% year-over-year.
United Technologies’ Free Cash Flow
United Technologies has been generating strong free cash flow and according to the company, it continues to anticipate free cash flow in the range of 90 to 100 percent of net income for the full year.
In the first quarter, cash flow from operations was $795 million and capital expenditures were $286 million. Free cash flow of 43% to net income was pressured by inventory build in support of the aerospace production ramp and included a payment of $237 million, the first of four annual payments related to the Canadian government settlement that was booked in the fourth quarter of 2015.
Source: Deutsche Bank Global Industrials and Basic Materials
Since the beginning of the year, UTX’s stock is up 4.7% while the S&P 500 Index has increased 1.3%, and the Nasdaq Composite Index has lost 3.4%.
However, since the beginning of 2012, UTX’s stock has gained only 37.6%, in this period, the S&P 500 Index has increased 64.7%, and the Nasdaq Composite Index has risen 85.6%.
UTX’s valuation is good, the trailing P/E is very low at 11.8, and the forward P/E is at 14.4. The price to sales is at 1.51, and the price to cash flow is at 14.0. Furthermore, the Enterprise Value/EBITDA ratio is very low at 9.95, and the PEG ratio is at 1.55.
United Technologies delivered better than expected first quarter results, and despite a slow-growth global macro environment, the company remains confident in its full-year 2016 earnings outlook of $6.30 to $6.60 per share.
I see healthy growth prospects for the company. United Technologies maintains a leading position in some key global industries, and it poised to benefit from population growth and the expansion of the middle class in developing markets.
Moreover, the company generates strong free cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments.
The company’s mix of growth, above-average dividend yield, and safety make give it a ‘Buy’ and Top 10 rank using The 8 Rules of Dividend Investing.