UTC’s Earnings Will Likely Rise on Strong Commercial Aviation Demand Despite Flat U.S. Military Spending

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United Technologies

United Technologies (NYSE:UTX) will announce its second quarter earnings Tuesday, July 22. The industrial conglomerate is coming off a good first quarter in which its organic sales rose by 5% annually on higher demand from the global commercial aviation sector, partially offset by weak U.S. military spending. [1]

In the second quarter, we anticipate United Technologies (UTC) to continue to post healthy growth in its sales on higher airplane engine shipments from Pratt & Whitney, and greater aviation component shipments from UTC Aerospace Systems (UTAS). The steadily recovering U.S. housing market will likely also support the company’s top line growth through higher sales at its Climate, Controls and Security (CCS) segment, which provides Carrier brand air-conditioners and Kidde/Chubb brand building fire and security systems. Partially offsetting this growth from commercial aviation and U.S. housing market, the flat-to-declining military spending from the U.S. government will likely weigh on the company’s second quarter results. [2] In addition, like in the previous quarter, restructuring charges could weigh on UTC’s profits in the second quarter. However in our view, margin expansion 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.

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See our complete analysis of UTC here

Higher Demand from the Global Commercial Aviation Sector Will Lift UTC’s Q2 Results

UTC generates roughly one-third of its revenues from the global commercial aviation sector. [2] Through its Pratt & Whitney segment, UTC is one of the largest engine suppliers to airplane manufacturers such as Boeing (NYSE:BA), Airbus and Embraer. The acquisition of Goodrich Corp. last year has also positioned UTC as a leading global supplier of airplane components, such as landing gears and nacelle. Thus, today the company is firmly positioned in the global aviation supply chain. Additionally, airplane makers including Boeing and Airbus are currently hiking their production rates in response to greater demand for commercial airplanes from airlines. This in turn is growing engine and airplane component shipments from Pratt & Whitney and UTAS, respectively. Separately, through its Sikorsky segment, UTC is also a leading manufacturer of commercial helicopters, which are seeing increasing demand from the offshore oil & gas production sector. In all, we figure these trends will drive strong growth in UTC’s second quarter revenues.

On the flip side, with the war in Afghanistan coming to an end and persisting budgetary pressures, the U.S. government’s military spending is declining. This is weighing on shipments of military airplane engines from Pratt & Whitney. However, UTC’s dependence on the government is much lower compared to its exposure to the commercial aviation sector, which is currently growing rapidly. We figure despite the weak military spending from the government, UTC’s commercial aviation business will drive healthy growth in the company’s results in the second quarter.

Recovering U.S. Housing Market is Driving Demand for UTC’s Residential HVAC Systems

Separately, the steadily growing U.S. housing market is driving sales of UTC’s residential heating, ventilation and air-conditioning (HVAC) systems. In the previous quarter, the company’s residential HVAC sales rose by 21% annually on higher demand from the U.S. housing market. [3] Generally, residential HVAC sales are a good indicator of the health of the U.S. housing market. This was highlighted in 2007, when UTC’s residential HVAC sales tanked, foretelling the upcoming downturn in the housing market. With residential HVAC sales currently continuing to rise in the U.S., we figure the country’s housing market will likely also continue to recover, supporting growth at UTC’s building businesses which include Otis and CCS.

Restructuring Costs Could Also Weigh On Q2 Results

All in all, we anticipate UTC to post strong growth in its second quarter profits, excluding the impact from its restructuring costs. Last quarter, these costs single-handedly clipped UTC’s profits despite growth in its top line. In the second quarter also, we expect an impact from these restructuring costs. This is so because the company anticipates to incur about $375 million in these costs for full year 2014, and it incurred more than a third of this – $125 million – in the first quarter itself. So, in the remaining quarters of 2014, the cost impact from restructuring activities will likely be more moderate. [1] [3] UTC undertakes restructuring activities, which include headcount reductions and plant consolidations from time-to-time, in an attempt to lower its operating costs. However, as these activities have one-time costs associated with them, they reduce profits for the quarter they are executed in. In our view, higher operating margins driven by these restructuring activities enable UTC to compete more aggressively, as higher margins enable competitive pricing. This has been highlighted at UTC’s Otis segment, which makes elevators and escalators. Large scale restructuring at this segment over the last few years has enabled it to compete more aggressively with lower-priced local alternatives in China. Thus, despite their one-time costs, we figure restructuring activities will benefit UTC over the long term.

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Notes:
  1. UTC’s 2014 Q1 earnings form 8-K, April 22 2014, www.utc.com [] []
  2. UTC’s investor and analyst meet presentation, March 13 2014, www.utc.com [] []
  3. UTC’s 2014 Q1 earnings presentation, April 22 2014, www.utc.com [] []