The investment case behind buying United Technologies Corporation (UTX 1.28%) rests on the idea that strategic investments made in the past few years will lead to significantly improved earnings and cash flow in the future. As such, it's a good idea to track strategic developments to gauge how well management is progressing on its long march to releasing value for shareholders.
Let's look, then, at the key takeaways from the recent fourth-quarter results, with a focus on the company's aerospace operations.
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Guidance and estimates imply growth
Management's 2018 guidance implies a pickup in organic sales growth accompanied by a significant increase in free cash flow and earnings-per-share (EPS) growth in the range of 3% to 6.8% range. The analyst consensus is for EPS of $7.02 and $7.82 in the next couple of years -- implying earnings growth of 5.6% and 11.4% over that period. On a headline basis, the company looks set to see the fruit of its labors in 2019.
|
Metric |
2015 |
2016 |
2017 |
2018 Estimate |
|---|---|---|---|---|
|
Earnings per share |
$6.30 |
$6.61 |
$6.65 |
$6.85-$7.10 |
|
Organic sales growth |
1% |
2% |
4% |
4%-6% |
|
Adjusted free cash flow (in billions) |
$5.10 |
$4.70 |
$3.60 |
$4.50-$5 |
Data source: United Technologies Corporation presentations. Does not include assumptions for Rockwell Collins.
In addition, the stock remains the most cheaply rated on an EV/EBITDA basis within its peer group, which includes General Electric Company (GE 1.65%) and other conglomerates with major aerospace operations.
UTX EV to EBITDA (TTM) data by YCharts
The question is whether you believe in the numbers -- something that requires having confidence in management's projections for its business units. Let's focus on aerospace (Pratt & Whitney and UTC Aerospace Systems) for now.
|
United Technologies Segment |
2017 Adjusted Operating Profit |
Midpoint 2018 Estimated Adjusted Operating Profit* |
2016-2020 Organic Sales Outlook |
|---|---|---|---|
|
UTC Climate Controls and Security |
$3,128 |
$3,278 |
3%-5% |
|
UTC Aerospace Systems |
$2,450 |
$2,625 |
5%-7% |
|
Otis |
$2,071 |
$2,121 |
3%-5% |
|
Pratt & Whitney |
$1,661 |
$1,711 |
10%+ |
Data source: United Technologies presentations. Figures in millions. *Includes foreign exchange effects.
Pratt & Whitney
It's mainly good news from Pratt & Whitney:
- CEO Greg Hayes affirmed that "every engine that's going out the door today" contained fixes for the two big technical issues -- carbon seal and combuster liner -- that had slowed production previously on the geared turbofan (GTF).
- GTF shipments totaled 374 in 2017, compared with guidance of 350-400.
- GTF shipments are expected to "almost double" in 2018, according to Hayes.
- Hayes outlined that there were 3,000 Airbus SE (EADSY 2.73%) aircraft on order that hadn't had an engine selected on them. The GTF competes with the LEAP engine from CFM International (a joint venture between General Electric and Safran) on the Airbus A320NEO.
- Eighty percent of GTFs are going out with fleet management programs in place, helping ensure long-term service revenue. Hayes suggested it would be 2020-2021 before meaningful GTF aftermarket revenue occurred.
- CFO Akhil Johri affirmed that the negative engine margin on the GTF -- losses taken on GTF sales before unit production cost cuts and aftermarket sales kick in -- would peak at $1.1 billion in 2018.
All told, the major technical issues on the GTF appear to have been fixed -- good news for Airbus as it ramps production on the A320NEO. Moreover, the GTF should start to regain order share against GE's LEAP, and management is confident on cutting unit production costs as it ramps up shipments of the engine.
Aerospace systems
The aerospace systems segment looks set for a better year in 2018, with ongoing strength in commercial aerospace aftermarket sales helping offset volume and mix headwinds with commercial original equipment (OE). The issue with the latter is that a number of new aircraft programs are causing a shift in revenue mix from legacy aircraft to new aircraft programs (newer parts initially come with lower margin, as it takes time to cut unit production costs) and the loss of a landing-gear contract on the Boeing 777.
Overall organic sales increased 2% in aerospace systems in 2017, but commercial OE sales turned positive in the fourth quarter, and management expects low-single-digit sales growth in commercial OE in 2018.
Somewhat puzzlingly, the forecast for commercial aftermarket sales growth in 2018 is only "low/mid-single" digits. It looks like a bit conservative, considering growth averaged 10% in the last four quarters and GE Aviation's spares rate grew to a rate of $27.4 million a day in its fourth quarter, compared with $20.2 million in the same period last year.
Data source: United Technologies Corporation.
Aerospace looks well set
It was a good update for United Technologies in aerospace. Aerospace systems confirmed the strength already seen in GE's aftermarket sales, and commercial OE sales look set to pick up.
Meanwhile, Pratt & Whitney's GTF looks set to compete more vigorously with GE's LEAP engine for orders on the Airbus A320NEO. In addition, the GTF production forecast is good news for Airbus as it seeks to ramp up A320NEO production, and because it's now a partner on Bombardier's C-Series program -- the GTF is the sole engine option on the C-Series.
All told, the fourth-quarter results and commentary show that United Technologies is on track with its strategic objectives in aerospace in 2018. That's good news for investors.
