United Technologies: The Path Ahead

Ever since Donald J. Trump was elected to be the next President of the United States, stocks have rallied upwards. Surprisingly, most of the investors buying stocks at the moment appear to be coming from the bond markets. This phenomenon has already earned itself a name – “the great migration”. If this trend is to continue, one can be certain that bonds and stocks that behave like bonds are going to under-perform, while some of the more economic sensitive sectors of the market are going to over-perform. The more pessimistic analysts believe that this is driven by fears of higher inflation and greater budget deficits, while the optimists say the market expects GDP growth to accelerate. Whatever the reason may be, the industrial conglomerate United Technologies (NYSE: UTX) could benefit significantly.

United Technologies has a nice blend of cyclical and non-cyclical businesses. Among the former are its commercial aerospace and building products businesses.  And among the latter are its defense aerospace products.  Furthermore, the company also has exposure in some strong trends, including a global growth in commercial aerospace and construction, most notably in India and China.

In the most recent quarter, earnings beat the consensus estimate by a notable margin. Revenues were driven in the quarter by higher sales in the aerospace and Pratt & Whitney segments. Additionally, the management has decided to raise the bottom end of the EPS outlook range by about $0.10 (on top of the $0.15 the company raised at the end of last quarter). The full year EPS is now expected to lie in the range of $6.55 to $6.60. Furthermore, the company has also raised the low end of the organic growth outlook. It now expects growth to be within 2% to 3% as opposed to the previous 1% to 3%.

Now 2% to 3% organic growth may not seem like much at first glance, one must keep in mind the headwinds that have weighed this figure down in the past few quarters. However, these headwinds are likely to dissipate going forward. Furthermore, in an accelerating cyclical economy, there should be even more of an upside ahead.

Among the current headwinds, Pratt & Whitney’s latest geared turbo engine has run into some problems in the year. The engine has taken about twice as long as expected to develop. Consequently, this has led to lower margins as well as contractual penalties paid to airlines. That said, customers that have received the engine are very satisfied with its performance. The low amount of noise produced and high power have enabled easier and safer takeoffs, while its fuel efficiencies have allowed longer flying times. It is expected that by the second half of next year, the fan blade production and the speed of manufacturing will improve significantly. This will lead to a boost in margins as we expect the geared turbo fan to be a game changer in the long run.

Additionally, Otis sales have suffered quite a bit in China this year. Equipment sales in the country were down 2% driven by an overall decline of about 13%. However, in all other regions, the Otis brand performed better year over year. While the outlook in China will remain weak in the immediate future, commercial construction could see an upturn as overall economic growth continues to remain strong. Furthermore, if the U.S. economy gets a boost under Trump, sales at climate control and security systems should perform well. UTC Aerospace could see increased military sales and military aftermarket sales as Trump plans a massive buildup of the military.

In conclusion, if the stock market continues to benefit from investors’ largess, we could see United Technologies stock over-performing. Its selective exposure to the aerospace, the U.S. economy and global commercial building (all of which may do well in the coming years) is going to help the company propel is stock price significantly. Furthermore, as the headwinds begin to abate, we could see the business really turnaround.

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