Why Pratt & Whitney’s Lower Aftermarket Part Sales Is Not A Big Concern?

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In the second quarter, when United Technologies (NYSE:UTX) reported a 6% drop in orders for large commercial engine spares at its Pratt & Whitney segment, serious questions about the segment’s aftermarket business arose. [1] Pratt & Whitney, which manufactures airplane engines and related spare parts, constitutes roughly a quarter of United Technologies’ (UTC) top line and the aftermarket business comprising of spare part sales constitutes a significant portion of Pratt & Whitney’s overall business. So, a decline in spare part orders may indicate that Pratt & Whitney’s aftermarket revenues could be hit in future. However, in our view, these concerns are misplaced as Pratt & Whitney’s aftermarket business is undergoing a fundamental change.

Earlier, Pratt & Whitney typically sold airplane engines and spare parts, which were bought by third parties contracted by airlines for engine maintenance. But, the declining active engine fleet of Pratt & Whitney’s legacy engines such as the PW2000, which powers the Boeing 757, weighed on the segment’s aftermarket spare part sales. To offset this impact on its aftermarket business, Pratt & Whitney increasingly focused on providing engine maintenance services by entering into long term fleet management programs (FMP) with airlines. Over the years, this shift in Pratt & Whitney’s aftermarket business from just being a parts supplier to a service provider has been very successful. In 2003, Pratt & Whitney had only 10% of its active engine fleet worldwide captured for maintenance through FMPs. This figure rose to nearly 50% in 2013 [2] So, today Pratt & Whitney’s aftermarket business is composed of not only spare part sales, but also service revenues. Therefore, the 6% year-over-year drop in large commercial spare orders in the second quarter at Pratt & Whitney is not alarming.

We currently have a stock price estimate of $119 for UTC, around 10% ahead of its current market price.

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See our complete analysis of UTC here

FMP Brings Greater Certainty In Pratt & Whitney’s Future Aftermarket Revenue

We figure this fundamental change in Pratt & Whitney’s aftermarket business is good for both UTC and airlines. For UTC, FMPs ensure regular cash flow as long as Pratt & Whitney’s engines continue to fly. In comparison, the cash flow from Pratt & Whitney’s aftermarket spare part sales isn’t as predictable. So, the aftermarket revenue of Pratt & Whitney is now more certain. For airlines, maintenance of their engines by Pratt & Whitney has increased the utilization rate of their airplanes. Pratt & Whitney by virtue of being the original manufacturer of these engines is able to provide better service than third party contractors. This has enabled airlines to fly their airplanes for more hours a month, allowing them to increase their income off airplanes.

Looking ahead, even as spare part sales related to legacy Pratt & Whitney engines come down, the segment’s aftermarket business will not suffer as its service revenue will likely grow. At a recent presentation, UTC said that it has FMP backlog is worth $30 billion covering all its engine lines. The capture rate for some of Pratt & Whitney’s newer engines such as the Geared Turbofan (GTF) is as high as 80%. [2] Meaning, 80% of GTF engines worldwide are covered by Pratt & Whitney’s service contracts. And, with the GTF engine set to constitute a growing share of Pratt & Whitney’s worldwide engine fleet, we figure the segment’s aftermarket business will likely grow in the coming years.

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Notes:
  1. UTC’s 2014 Q2 earnings form 8-K, July 22 2014, www.utc.com []
  2. UTC’s presentation at Morgan Stanley conference, September 6 2014, www.utc.com [] []