European Slowdown And Military Weakness Temper UTC’s Growth From Commercial Aviation

by Trefis Team
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United Technologies
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    Quick Take
  • UTC posted strong growth in its profits in the third quarter driven by rising demand from commercial aviation and gains from cost-controlling measures.
  • However, the company’s growth was tempered by the extended slowdown in Europe and lower defense spending from the U.S..
  • Looking ahead, the company anticipates these trends to persist at least in the near term.

United Technologies‘ (NYSE:UTX) third quarter sales rose by 3% annually to $15.5 billion driven by rising demand from commercial aviation and China, which was partially offset by continued slowdown in Europe and lower military spending from the U.S. government. [1] Acquisitions including those of Goodrich and International Aero Engines (IAE) added two points of growth while organic sales contributed one point of growth to the company’s top line in the third quarter, on a year-over-year basis.

United Technologies (UTC) also benefited from its restructuring and cost-controlling activities which expanded its segment operating margins to nearly 16% in the third quarter, from 14% in the same period last year. Higher margins boosted the moderate growth in the company’s top line to lift its third quarter profits by 13% annually to $1.4 billion. [1]

Orders across most UTC segments also rose in the quarter which allowed the company to raise the lower end of its full year 2013 earnings guidance. UTC now expects its 2013 earnings to grow by 14-15% annually to $6.10-6.15 per share. However, extended weakness in Europe prompted the company to revise downward its 2013 top line guidance by $1 billion to $63 billion. [2]

We currently have a stock price estimate of $116 for UTC, around 10% ahead of its current market price. We are in the process of incorporating the third quarter earnings and shall update our analysis shortly.

See our complete analysis of UTC here

Demand From Commercial Aviation Lifts Results

During the third quarter, sales of UTC’s commercial aircraft parts and engines continued to rise, driven by demand from commercial aviation. At Pratt & Whitney, sales of commercial engine spares rose 22% annually and at UTC Aerospace Systems, which manufactures aircraft parts, sales to original equipment manufacturers such as Boeing (NYSE:BA) and Airbus rose. [1]

Commercial aviation is growing due to rising demand for flights from the emerging markets and replacement (of older aircraft) demand from the developed markets. These demand trends are propelling airlines to place orders for new aircraft with manufacturers such as Boeing, Airbus, Bombardier and Embraer. This has resulted in surging order backlogs at most manufacturers forcing them to hike their production rates, which in turn is increasing sales of commercial aircraft engines and parts. UTC being one of the largest manufacturers of commercial aircraft engines and parts is thus seeing its sales from commercial aviation rise.

Defense Budget Cuts Impact Q3 Growth

However, in the third quarter, UTC’s growth from commercial aviation was offset in part by lower military spending from the U.S. government. The impact was most evident at Sikorsky where sales fell by 7% annually. Sikorsky’s military aircraft shipments fell to 42 in the third quarter, from 52 in the prior year period. [3] UTC has a significant dependence on the government with the latter constituting $11 billion of its $57.7 billion revenues last year. [4] Apart from Sikorsky, UTC’s other segments namely Pratt & Whitney and UTC Aerospace Systems also cater to the military needs through their military aircraft engines and other aircraft parts.

Additionally, the ongoing slowdown in Europe also tempered UTC’s growth in the third quarter. The industrial conglomerate’s commercial sales from Europe fell by 1% annually in the quarter. On the bright side, sales from China grew 11% annually and those from North America also recovered by 3% annually in the third quarter. [3]

Outlook

Looking ahead, in the near term, UTC faces a mixed macro environment with an extended slowdown in Europe and lower U.S. military spending threatening to offset the growth from commercial aviation. However, we figure that over the long term, the company will benefit from rising urbanization in emerging countries which will create demand for its building market related businesses, namely Otis, Carrier ventilation and air-conditioning systems, as well as fire and security systems. We figure UTC’s recent decision to merge these segments in to a single building market focused segment, called UTC Building and Industrial Systems, will help it better capture opportunities emerging from the growing urbanization in the emerging markets. (See UTC Reorganizes Otis, Carrier, Fire & Security Units Under One Roof To Spur Growth)

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Notes:
  1. UTC’s 2013 Q3 earnings form 8-K, October 22 2013, www.utc.com [] [] []
  2. UTC’s 2013 Q3 earnings form 8-K, October 22 2013, www.utc.com []
  3. UTC’s 2013 Q3 earnings presentation, October 22 2013, www.utc.com [] []
  4. UTC Overview presentation – investor and analyst meeting, March 14 2013, www.utc.com []
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