How Is United Technologies Weathering U.S. Defense Spending Cuts?

United Technologies (NYSE:UTX) is posting strong growth in its sales and profits on growing commercial aviation demand and rising global urbanization. Last quarter, the company’s top line rose by 16% annually and its earnings by 5% annually driven by these major trends. ^[1] However, since United Technologies (UTC) also derives a significant portion of its business from the U.S. government, it is important to understand if the company is well positioned to weather the impact from government austerity, especially across-the-board spending cuts – sequestrations – which kicked in starting in March this year. In 2012, UTC generated around $11 billion of its $57.7 billion revenues from the U.S. government. ^[2]

We are of the view that despite this high degree of dependence on the government, UTC is well positioned to weather the impact from government’s budget cuts, especially the defense spending cuts as it is part of major defense programs and has high prospects of converting a few upcoming multi-billion dollar government programs. Growth in international military orders are also helping the company offset the impact from lower defense spending at home.

We currently have a stock price estimate of $116 for UTC, around 10% ahead of its current market price.

See our complete analysis of UTC here

UTC supplies defense equipment and systems to the government from three out of its five segments namely Pratt & Whitney, which provides military aircraft engines; Aerospace Systems, which supplies military aviation components; and Sikorsky, which provides military helicopters. All of these segments also serve commercial markets; however, here we analyze their positions in the light of declining defense spending from the U.S. government.

Since 2011, the U.S. government’s defense budget has declined steadily due to the enactment of the Budget Controls Act, which slashed the government’s defense spending by around $500 billion over 2011-2021. In March, earlier this year, additional reductions to the government’s defense budgets were introduced under across-the-board spending cuts called sequestrations.

Higher Volumes In F-35 And CH-53K Programs

We believe the impact on UTC from these spending cuts will be tempered by the company’s presence in some major defense programs, which are viewed in line with government’s defense priorities and are thus likely to avoid cuts.

The most important of these programs is the F-35 Joint Strike Fighter (JSF) program where Pratt & Whitney supplies the engine for the F-35 fighter aircraft being developed by the program’s chief contractor Lockheed Martin (NYSE:LMT). Currently, under the low rate initial F-35 production, Pratt & Whitney’s delivery volumes of the JSF engine are around 30-40 per year. However, 2015 onward with ramp up in production, annual engine delivery volumes are expected to rise to over 200 per year by the end of the decade. ^[3] This growth from JSF engine deliveries will to a large extent offset the impact from government’s budget cuts on UTC’s smaller defense programs.

Additionally, delivery volumes of the Sikorsky CH-53K heavy-lift helicopter to the United States Marine Corps are also expected to pick up towards the end of this decade. UTC expects to deliver around 8-10 of these helicopters per year by 2020, and anticipates to deliver a total of 200 of these helicopters to the U.S. Marine Corps at an overall program cost of $23 billion. ^{[3] [4]} Currently, the CH-53K is undergoing ground testing with its first flight scheduled for next year. In all, higher volumes from this Sikorsky program will also help UTC weather the impact from lower government defense spending in the coming years.

U.S. Government’s Future Helicopter Programs

Separately, Sikorsky’s technologically advanced portfolio supported by its strong research and development capabilities will help it in winning future helicopter programs of the U.S. government, to further shore up its sales to the government. Some of the major government copter programs that are expected to close over the coming years include the Presidential helicopter deal involving 23 aircraft, Combat Rescue helicopter deal involving 112 aircraft for the US Air Force and Armed Aerial Scout helicopter deal involving 428 aircraft for the U.S. Army. ^[3] All these deals are multi-billion dollar ones and Sikorsky is one of the front runners in all of them. For instance, in the Combat Rescue helicopter deal, Air Force will likely pick Sikorsky as all other bidders have opted out of the competition, and in the Presidential helicopter deal, Sikorsky will benefit from its past experience of having provided the President’s helicopter fleet.

Rising International Military Orders

The impact from lower government spending on UTC is also being offset by growth from international defense orders. Rising international military spending driven by India, South Korea, Saudi Arabia among others is raising orders for many defense system manufacturers, including UTC. During 2010-2012, UTC’s international defense orders increased from around a couple of hundred millions to over $1.5 billion. ^[3] Looking ahead, we anticipate continued growth from these international defense orders, which will work to temper the negative impact from government austerity.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. UTC’s Q2 2013 earnings form 8-K, July 23 2013, www.utc.com [↩]
2. UTC Overview presentation – investor and analyst meeting, March 14 2013, www.utc.com [↩]
3. UTC at 2013 Paris Air Show, June 18 2013, www.utc.com [↩] [↩] [↩] [↩]
4. Sikorsky CH-53K Super Stallion, August 19 2013, www.wikipedia.com [↩]