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United Technologies (UTX)

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WHAT HAS CHANGED?

  1. Rockwell Collins Acquisition To Close Soon

The company concluded the acquisition of Rockwell Collins in Q4. In general, the company and investors alike, are very excited about the integration. Collins Aviation (the name of the combined company), will give the conglomerate the chance to differentiate its products, by adding more intelligent services to its portfolio. This, in turn, will ensure an enhanced customer value, which is expected to help the company gain more market share over the long-term. Additionally, the deal is also expected to deliver at least $500 million in net cost synergies.

  1. Pratt & Whitney See Revenues Jump

Pratt & Whitney was the star of the quarter at United Tech this time around as well. The segment managed to post a significant 12% increase in organic growth. This figure was driven by robust military sales and increased GTF deliveries. In fact, this was the first ever quarter to record over 200 engine deliveries at the segment in a quarter. We expect the segment to deliver a record number of engines in the year, which is bound to grow the top line even more. In general, Pratt has about seven years of GTF backlog and has close to 8,500 total firm option orders to date.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

  • Pratt and Whitney EBITDA margins: This is a promising business for UTC as the company is investing in researching and developing new state of the art aviation engines. The company has a contract with the U.S. Air Force to develop the F-135 engine for its F-35 jets while also developing a liquid fuel J-2X engine to support NASA’s vision for space exploration. If it is able to meet these challenges, it will be able to command a premium for its products, leading to an increase in Pratt and Whitney EBITDA margins. Should this occur, and margins exceed 20% versus our forecast of around 13.8% by the end of the Trefis forecast period, there could be a potential upside of nearly 10% to the current price estimate.
  • Otis EBITDA margins: With local competitors in international markets trying to compete against Otis on the basis of price, Otis' profitability might take a dip if it is not able to lower its costs. If that happens, Otis' EBITDA margins could fall to about 14% by the end of the forecast period, thus providing a downside of about 10% to the Trefis price estimate.

BUSINESS SUMMARY

United Technologies (UTC) is a diversified industrial conglomerate. The company's brands and products include Carrier heating and air conditioning systems, Otis elevators and escalators, Kidde/Chubb fire and security systems, Pratt & Whitney aircraft engines, and Goodrich aerospace systems and components. The company's various businesses are leading players in their respective categories. UTC conducts its business through about 4,000 locations in 71 countries and generates over 60% of its revenue from outside the U.S., including U.S. exports.

UTC's business is essentially aligned with the global aerospace sector and global building markets. The company's products are sold to both retail and commercial customers.

UTC invests large amounts in research and development, spending over of $2.5 billion each year on R&D. The company also conducts customer-funded research of around equal value.

SOURCES OF VALUE

Pratt and Whitney's Geared Turbofan Engine

Constant innovation in aircraft engines is demanded by both airplane makers and airlines, as fuel costs constitute the largest expense head for airlines. Consequently, airplane engine makers such as Pratt & Whitney have to constantly improve the fuel efficiency of their engines. Over the last few years, Pratt & Whitney has been able to develop the Geared Turbofan Engine (GTF), which has been promised to be 10-15% more fuel efficient than existing engines on regional and single-aisle aircraft.

This engine gas been selected as the exclusive engine for Mitsubishi Regional Jet (MRJ), Bombardier CSeries and Embraer’s second generation of E-jets, and as an engine option on the Airbus A320neo and the Russian Irkut MC-21.

We figure this GTF engine will be a major growth driver for Pratt & Whitney in coming years. And now with rollouts and problems solved, we can already see a positive impact on revenues.

Otis' leading position will allow UTC to capture growth in the global elevator market

Otis is the world's largest elevator and escalator manufacturer with a very strong brand. The company is also the market leader in China, which is the world's largest as well as the fastest growing elevator market. As the demand for elevators and escalators rises, especially from the emerging countries, Otis should manage to capture a significant portion of this demand. However, in the recent past, Otis has seen business in China decline on the back of adverse pricing pressures and decreasing urbanization projects - a problem, which could hurt revenues in the region for the foreseeable future.

KEY TRENDS

Rising Air Passenger Traffic

Global airline passenger traffic is rising driven by a steadily growing global economy, rising trade and globalization. Forecasts from Boeing anticipate the global airline passenger traffic to grow by around 5% per year through the next two decades.

The rising passenger traffic has also lifted airline profits, enabling them to place orders for new airplanes. According to figures cited by UTC, driven by this rising global air passenger traffic, approximately 37,500 new commercial airplanes will be delivered to airlines over the next 20 years, up from around 19,000 commercial airplanes that were delivered to airlines over the past 20 years. This tremendous growth in commercial airplane deliveries will benefit both Pratt & Whitney and UTC's Aerospace Systems' segment.

Deal with Rockwell Collins

In October, United Technologies managed to close the much awaited acquisition deal with aircraft parts manufacturer Rockwell Collins for nearly $30 billion, which includes $7 billion in net debt. The deal enables UTC to benefit from several operating synergies through lower costs, with more opportunities to cross-sell each company's products. Such benefits are expected to make the company a significantly more important supplier of components to mammoth aircraft manufacturers like Boeing and Airbus, thereby increasing its bargaining power in the aerospace supplier market.

Urbanization

As large number of people migrate from rural areas to cities in the less developed regions of the world, demand for residential and commercial buildings along side other physical infrastructure will rise. As UTC’s building products enable construction of new buildings we figure the company has a tremendous growth opportunity on its hands. The key building products of UTC include Otis elevators and escalators, Carrier heating, ventilation and air-conditioning (HVAC) systems and Kidde/Chubb fire prevention and security systems. Additionally, as these products are leading players in their respective segments, we figure the company will bag a large share of the growth that is anticipated in the global building market.

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