Monday, April 7, 2014

Military Gives Congress a $36 Billion Wish List-04/11/2014
Topic company:
United Technologies Corp.Diversified MachineryUSA


  1. Sources: Bloomberg, Seeking alpha, Morningstar, 10K, WSJ

    United Technologies (UTC) is a diversified industrial conglomerate, serving primarily construction and aerospace markets.
    (Reference items: 2013 rev 62.6 billion, operating income 8.1 billion, FCF 5.2 billion
    Five operating segments (% of rev, and % of operating income)

    UTC climate, controls and security 27%, 27%
    UTC Aerospace system 21%, 21%
    Pratt& Whitney 23%, 19%
    Otis 20%,27%
    Sikorsky 10%, 6%

    UTC aerospace system provides aerospace products and after-market services. Its clients include aircraft manufacturers, airlines,aviation markets, military, space and undersea operations.
    UTC CCS is the leading provider of Heating Ventilation Air Conditioning (HVAC) and refrigeration solutions, including controls for residential, commercial, industrial and transportation application, These products are sold under the Carrier name.
    PW is one for the world's leading suppliers of aircraft enignes for the commercial, military, business jet and general aviation markets. PW provides maintenance, repair and overhaul services, including the sale of spare parts, as well as fleet management services for large commercial engines.
    Otis is the world's largest elevator and escalator manufacturing, installation and service company. It designs, manufactures, sells and installs a wide range of passenger and freight elevator for various applications, It sells directly to the end customers through sales representative and distributors.
    Sikorsky is among the world's largest helicopter companies. It manufactures military and commercial helicopters and also provides after-market helicopter and aircraft parts and services.

  2. Hightlights
    R&D expenses accounts for 4.04% of industrial, higher than industrial median of 2.5%.
    Positive revenue growth from 2009-2012, avged 2.9%, rev growth in 2013 8.5%, NI margin 9.1%,
    FCF/rev= 8.3%.
    Uses of FCF
    CapEx 32%
    Dividends 37%
    Share repurchase 23%
    Debt repayment 55%

    (Used BI preselected peers)
    P/E ratio: UTX 18.3 higher than industry median of 16.8
    FCF yield: UTX 5.1%, higher than industry median of 4.4%

    Economic Moat
    United Technologies has a wide firm wide moat.
    Otis elevator: limited competition, strong brand recognition, extremely high switching costs. In short, Otis elevator business can face up the competition, and maintain healthy margins.
    On the aerospace side, Pratt benefits from high switching costs and strong service revenue.
    The Carrier air conditioning division faces increasing competition from low-cost manufacturers. This segment's sales and margins might be adverse impacted by competition and price war.
    UTC aerospace systems benefits from high switching costs, since its products enjoy entrenched positions at many aircraft manufacturers.
    Sikorsky continues to be a strong player in the military market, with well-regarded products and an entrenched base.
    Finally, the fire and security product line operates in a fragmented market where the firm's scale advantages determine profitability.
    Consequently, UTC's ROIC averaged 15% over the past five years.

    - New engines and improvement in existing engines drive continuous demand for Pratt and Whitney products. Aircraft manufacturers demand for powerful, more efficient engines allows for consistently strong demand for the company's products without much cyclicality (despite the cyclical nature of the airline industry). Constant innovation in the aircraft engine space can stimulate the sales. Many airlines are replacing older aircrafts with better engines. According to Boeing estimates, around 35,000 new commercial airplanes will be delivered over the next twenty years. All previous mentioned premises provide a huge opportunity for aircraft parts and engines that are manufactured by UTC.
    - Chinese president Xi Jingping visited France in March, and signed a massive aerospace contract with various suppliers. EC175 helicopters are powered by Pratt& Whitney, UTX benefited from an extensive partnership with China's SOE AviChina.
    - UTX can generate a lot of extra revenue from China's implementation of commercial and general aviation 5-year plan. Based on a WSJ report, the additional revenue could total 11 billion for PWC division alone over the next 20 years. That is a guaranteed 3.8% revenue growth, as 2013 revenue per annum.
    - Growth in emerging markets: Urbanization in emerging countries will create more demand for Otis products. Otis can expect its revenue to ride along with the recovery of global constructions. As the middle class grows in those countries wand disposable income increase, there will be a substantial increase in the demand of HVAC products.

    - Adverse commodity costs fluctuation can negative impact UTX's major operations.
    - US government is a major clients of UTX, contributing 16% of revenue. Winning contracts are important to UTX, but are subject to regulation and policy changes.
    - Pratt will see more demand from favorable environment. (Backlog doubled in 2012, declined 11% in 2013). Its sales growth and profitability hinges on its ability to execute in a faster-pace. Fail to do so will impair revenue and net income and potentially company reputation.

    Currently, 27 analysts cover UTX, 21 issued buy, 6 hold, 0 sell. (Bloomberg) Rapid advances in technology: Results shortened technology life cycles, and successful companies rely on constant innovations. UTX spends more on R&D, in terms of as a % of rev, and currently it dominates in many of the industries it operates in. UTX is well positioned with wide moat in highly entrenched industries. Profitability and growth also ratios lead competitors.

  3. Sources:
    - 2013 10K
    - Seeking alpha
    - Zacks

    Business Overview: United Technologies Corporation provides a broad range of high-technology products and services for the aerospace and commercial building industries worldwide.

    It has five business segments: (% of total revenue in FY 2013; % of operating income in FY 2013)
    Commercial Business:
    - UTC Climate, Controls & Security:27%;27%
    - Otis:20%;27%
    Aerospace Business:
    - Pratt & Whitney:23%; 19%
    - UTC Aerospace Systems: 21%;21%
    - Sikorsky:10%;6%

    Largest Segment: UTC Climate, Controls & Security
    - the leading provider of HVAC and refrigeration solutions & a global provider of security and
    fire safety products and services
    - Two Businesses: Carrier & UTC Fire & Security
    - 9% operational profit increase: driven largely by the benefits of restructuring actions and cost productivity (combined 4%), volume growth (3%), and favorable commodity costs (2%)

    - Aerospace customers include governments, aircraft manufacturers and airlines
    - Building systems customers include architects, building owners and managers, contractors, and property developers

    Competitors for the major business units:
    - Pratt & Whitney: GE & Rolls Royce
    - UTC Aerospace Systems: Honeywell, Northrop Grumman
    - Sikorsky :Bell Helicopter Textron, and Airbus Helicopters
    - UTC Climate, Controls & Security: Johnson Controls
    - Otis: ThyssenKrupp

    Financial Overview:
    - FCF: 5.1 b, increased 37% in 2013, no negative Free Cash Flows over the last 10 years
    • FCF as % of Rev: 8.14% in 2013, 6.44% in 2012, 9.64% in 2011, 9.28% in 2010
    • FCF as % of OCF: 68% in 2013, 56% in 2012, 85% in 2011, 85% in 2010
    • Use of FCF:
    o Share Repurchase: 24%
    o Dividend payment: 37%
    o Debt Repayment: 56% of FCF, repayment of long-term debt used for 2012 acquisition of Goodrich
    - Profitability: ROE 18.9% ; industry avg. 12.3%; Operating Profit Margin 15.3%, increased 1% in 2013
    - Financial position: D/E 0.59 by 2013 year-end

    What is going right?
    - The global demand for elevator, escalator, and security systems will remain strong, which will boost the company's revenues in the coming years
    - As a leading player in China, continuing strong growth in emerging market, principally China, is the growth drivers for the company in future in both aerospace business and commercial business
    - Synergies realized from the acquisition of Goodrich: With the acquisition of Goodrich, it has become one of the largest global aerospace suppliers. The company has recorded a 60.2% increase in the UTC Aerospace systems segment's revenue for the current year as a result of this acquisition.

    What can go wrong?
    - Revenue:
    • Reduction in government budgetary allocation for the defense. The company is 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 its products since government is one of its main customers in its aerospace business
    • Risks associated with new products and technologies innovated. The company designs, manufactures and services products that incorporate advanced technologies, which may not achieve expected benefits and timeline, and eventually influence revenue
    • Global economic conditions, foreign currency fluctuations and changes in local government regulation
    - Expenses:
    • Expenses associated with its acquisition with Goodrich in 2012 may increase during the integrating process
    - FCF:
    • May need more FCF as its looking for new acquisition opportunities
    Overall speaking, optimistic future outlook, and strong growth, a good long-term hold.

  4. 2013 Annual Report
    Seeking Alpha
    Morning Star


    United Technologies, is an industrial conglomerate with a wide variety of business line providing high-end technology products and services to the building systems and aerospace industries worldwide.

    5 Business Segments (Revenue %, Operating Income %) Fiscal year 2013

    Flight Systems 31% 27%
    UTC Aerospace systems 21% 21%
    Sikorsky (helicopter) 10% 6%
    UTC Climate, Controls & Security (refrigeration) 27% 27%
    Pratt & Whitney (aircraft engines) 23% 19%
    Otis (elevator) 20% 27%

    CORE BUSINESS - Flight Systems
    - Organic sales increased 3% in 2013 due to higher sales (3%) primarily in China, the U.S. and Russia partially offset by declines in South Korea.
    - The organic sales increase (2%) was primarily driven by higher commercial engine sales volume (2%), higher military aftermarket and development program sales (2%)
    - Aerospace systems, Sikorsky and Pratt benefits from high switching costs and strong service revenue (This is a wide moat for UTX)
    - High profit margin for aftermarket service for aircraft engine, helicopter and aerospace systems

    - Flight systems: commercial airlines, aircraft manufacturer, government and militaries.
    - Otis: commercial and residential construction and development companies
    - UTC Climate, Controls & Security: electrical and machinery business clients

    - Profitability: Gross margin 27.6% remain constant in last five years
    - ROE: 19.7% in 2013, industry average: 13%,
    - Financial Position: Debt/ Equity: 0.62 decrease 20% from 2012
    - Cash and cash equivalents were $4.6 billion with long-term debt of $19.7 billion.
    - UTX recorded compound annual growth of 0.8% for sales
    - Return on invested capital (ROIC) was 13.2% in 2013 versus 11% in 2012,
    - 2014 Guidance: EPS estimate to $6.78 from $6.86

    Free Cash Flow:
    - FCF in FY 2013 - 5.1 billion 37% increase from 2012
    - FCF/Rev: 8.4% in 2013, increase 2% (peer average of 6.7%)
    - FCF/CFO: 18% in 2013, increase 6%

    Use of FCF
    - Dividend: $ 1.9 billion
    - Share repurchase: $ 1.2 billion,
    - Pay down debt: $2.8 billion
    - Reinvestment: Invest in innovative new products
    - In July 2012, UTX purchased aerospace competitor Goodrich

    - Aerospace Business competitors are BOEING, Airbus Group NV,GENERAL DYNAMICS, BAE Systems
    - UTC Climate, Controls & Security: Rolls-Royce Holdings, Johnson Controls
    - Otis (elevator):
    PRO (what is going right now
    - Sales increasing in Emerging market: the company should also benefit from secular growth in commercial and residential construction in emerging markets.
    - Merge with Goodrich: The integration of Goodrich will allow UTX to provide a more integrated product to aircraft manufacturers such as Boeing and Airbus, which are ramping up production of new fuel-efficient planes.
    - Strong aftermarket business: 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 spare parts and offer related services to keep those primary products running.

    CON (what may go wrong)
    - Dependence on government budget: The company is also highly dependent on the U.S. government s budgetary allocation for defense.
    - Slowdown in emerging market construction demand, particularly in China.

    - Profit margin erosion at Otis
    - Increasing expense in integrating Goodrich,
    - Increasing Raw Materials and Supplier-Provided Parts cost

    - Fluctuations in foreign currency exchange rates also affect the company s net investment in foreign subsidiaries and may cause instability in cash flows relate to foreign denominate transactions.

  5. UTX
    Data sources: 10-K,,
    UTX provides high technology products and services to the building systems and aerospace industries worldwide.

    Revenue breakdown

    • Otis 19.7% 26.8%
    • UTC Climate, Controls & Security 26.5% 26.8%
    • Pratt & Whitney 22.9% 19.4%
    • UTC Aerospace Systems 21.1% 20.9%
    • Sikorsky 9.9% 6.1%
    • Reorganization for better service
    • Sikorsky, helicopter production and services segment, faced a very challenging

    Commercial customers such as real estate developers, plane manufacturers and military customers

    Free cash flow
    2011 9.6% 85.1%
    2012 6.4% 55.9%
    2013 8.1% 67.9%

    Usage of free cash flow in 2013
    Acquisition 27.7%
    Debt repayment -56.2%
    Common stock repurchased -23.6%
    Dividend paid -37.4%
    Paid nearly 70% of its free cash flows to investors over the past seven years.

    Financial performance
    Gross Margin % 27.6 27; improving & highest
    Operating Margin % 14.7 13.3; improving & highest
    Net Margin % 9.14 8.89; improving & highest
    Revenue growth 3-Year Average 4.85%

    Bull cases
    • Limited competition, strong brand recognition, and extremely high switching costs
    • Emerging countries urbanization trend.

    What could go wrong
    • U.S. Department of Defense spending
    • 61% of its sales from international markets
    • Cyclicality of construction and aerospace segments.