UTC’s Earnings Preview: Restructuring Costs Will Likely More Than Offset Sales Growth

United Technologies (NYSE:UTX) will announce its first quarter earnings Tuesday, April 22. The industrial conglomerate is coming off a good last year in which its revenues rose by 9% annually, driven by the Goodrich acquisition. ^[1] The company’s organic sales also picked up steadily through 2013 on higher demand from commercial aviation, partially offset by lower military spending in the U.S.. The company’s 2013 earnings also posted strong growth on additional gains from cost reduction measures.

In 2014, in the absence of any major acquisition, we anticipate the growth in United Technologies’s (UTC) results to be more moderate. The company forecasts its 2014 revenues to rise by around 2% annually to $64 billion and its 2014 earnings to rise by 5-10% annually to $6.55-6.85 per share. ^[2] Higher demand from commercial aviation will likely continue to drive UTC’s 2014 results with greater shipments of aircraft engines from Pratt & Whitney and of spare parts from the UTC Aerospace Systems segment. On the flip side, with the war in Afghanistan coming to an end, demand for Sikorsky’s military helicopters and spares will likely fall, tempering UTC’s 2014 growth.

In the first quarter, the company guides its earnings to fall by 10% annually to around $1.25 per share due to restructuring costs more than offsetting moderate sales growth. ^[2] However, we figure margin expansion gains driven by these restructuring activities will benefit UTC over the long term.

We currently have a stock price estimate of $121 for UTC, around 5% ahead of its current market price.

See our complete analysis of UTC here

Restructuring Costs Will Dig Into UTC’s First Quarter Earnings

UTC undertakes restructuring activities like headcount reductions and plant consolidations from time to time in an attempt to lower its operating costs. However, these activities have one-time costs associated with them. Last year, the company incurred $481 million in these restructuring costs, but restructuring played a key role in expanding its segment operating margins to nearly 16%, from under 15% in 2012. ^[1] In the first quarter, UTC anticipates restructuring costs to dilute its earnings by 18 cents a share, more than offsetting 15 cents a share of expected organic growth. ^[2] However, in our view, these restructuring activities, by lowering operating costs, will help further expand the company’s margins in 2014.

Additionally, higher margins, which enable competitive pricing, will enable UTC to compete more aggressively with its peers. For instance, lower cost structures resulting from restructuring at UTC’s Otis segment, which makes elevators and escalators, enabled the segment to compete more aggressively with lower-priced local alternatives in the fast growing elevator market of China. So, we figure over the long term, gains from higher margins driven by these restructuring activities will more than offset their one-time costs.

Commercial Aviation Will Drive UTC’s Sales Growth

Separately, in the first quarter, UTC’s sales growth will be driven by the global commercial aviation sector. Higher demand for aircraft engines and other components from original equipment makers such as Boeing (NYSE:BA) and Airbus is pushing up engine shipments of Pratt & Whitney and aircraft component shipments of UTC Aerospace Systems (UTAS) segment. Airplane makers are hiking their production rates in an attempt to make timely deliveries against soaring orders from airlines worldwide. Currently, UTC, through Pratt & Whitney and UTAS, generates around a third of its overall revenues from the global commercial aviation sector. But, the company also generates approximately 20% of its revenues from military markets, primarily U.S. government military spending, which is falling due to the end of war in Afghanistan and fiscal constraints. ^[2] So, we figure the weakness in UTC’s military markets will temper its growth from commercial aviation in the first quarter.

We will also watch UTC’s building segment results for any signs of recovery in commercial construction spending from Europe. Last year, weak construction spending from Europe weighed on results of UTC’s building market related segments, which include Otis and Climate, Controls and Security (CCS). The latter makes Carrier brand heaters, ventilators and air conditioners (HVAC) and provides fire and security solutions from brands that include Kidde and Chubb.

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1. UTC’s 2013 10-K, Fenruary 6 2014, www.utc.com [↩] [↩]
2. UTC’s investor and analyst meet presentation, March 13 2014, www.utc.com [↩] [↩] [↩] [↩]