We are reaffirming our Neutral recommendation on United Technologies Corp (UTX). The company delivered a strong performance in the fourth quarter of 2011, driven by growth for Carrier. Furthermore, the company generated strong cash flow during the latest reported quarter.
In addition, the acquisition of Goodrich during the third quarter is also expected to boost revenues in fiscal 2012. UTX also made changes to its business portfolio during the quarter to help serve its customers better and improve its sales growth, moving forward. However, the weakness in the global construction market and the long-cycle business pattern of the company are a concern.
United Technologies’ current trailing 12-month earnings multiple is 15.1x, compared with the 35.5x average for the peer group and 14.8x for the S&P 500. Over the last five years, UTX’s shares have traded in a range of 8.1x to 20.0x trailing 12-month earnings. Therefore, it is nearly at the high end of the historical range, indicating that upside, if any, will be very moderate.
The 9% discount to the peer group based on our forward estimate for 2012 is much less than the historical average of 41%, indicating very minor upside. However, considering the fact that United Technologies’ expected earnings growth of 11.4% over the next 5 years is almost as same as the growth of its peers at 11.1%, we think the valuation is justified.
United Technologies is a diversified business conglomerate serving various end-markets such as aerospace, defense and commercial construction, which move according to their own cycles. Therefore this mixture and diversification allows the company to remain profitable even during tough economic times, delivering consistent earnings and dividend growth.
United Technologies has a strong aftermarket business. The company not only manufactures and sells primary products such as elevators, aircraft engines and helicopters but also sells parts and offers related services to keep those primary products running. The company’s aftermarket business accounts for 35% of its total revenues and since aftermarket services is relatively stable compared to new product delivery, it helps offset the negative impact of downturns in the new products market.
However, on the flip side, the financial performance of the company depends on the conditions of the construction and aerospace industries. The company is also highly dependent on the U.S. government’s budgetary allocation for defense.
A reduction in capital spending for the commercial aviation or defense industries could have a significant effect on demand for UTX products, which could have an adverse impact on its financial performance or its results of operations. Its business may also be affected by government contracting risks.
In addition, the company’s international operations are subject to economic risks, and results of operations may be adversely affected by changes in economic conditions, foreign currency fluctuations and changes in local government regulation.
United Technologies currently holds a Zack Rank #3 which implies a short-term Hold rating on the stock.
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