United Technologies (NYSE:UTX) CEO Greg Hayes' recent presentation at the Morgan Stanley Laguna Conference was unique in the sense that it contained many nuggets of information, not just for United Technologies, but actually for many different companies. Not only was it relevant for its future merger partner Raytheon (NYSE:RTN), but also for future investors in the companies (Otis and Carrier) that Hayes will spin off. Let's look at the key takeaways from the presentation.
1. Company outlook
Although Hayes didn't make any changes to the company's full-year guidance -- organic sales are still expected to grow in the 4% to 5% range, with adjusted EPS of $7.90 to $8.05 -- but he did say something that suggested some upside pressure on full-year guidance. Hayes noted that the EPS accretion from the Rockwell Collins takeover would be "north" of the $0.50 forecast in the second-quarter earnings presentations. For reference, the estimate of $0.50 was upgraded from initial guidance for $0.35.
Hayes attributed the upward revision to better-than-expected performance in the legacy Collins business, specifically in the commercial aerospace aftermarket -- an end market that has been very strong this year.
2. Raytheon Technologies will be a cash-generating machine
At the time the United Technologies/Raytheon deal was announced, management outlined that the future Raytheon Technologies is projected to generate around $8 billion in free cash flow (FCF) in 2021. However, later Securities and Exchange Commission filings suggested that free cash flow (measured in a different way) could generate $9.3 billion in the same time frame.
Outlining the difference in the forecasts on a later SEC filing, it appears that $1 billion worth of the difference comes down to a line item covering "contingency/investment flexibility." In other words, management has given itself the flexibility to invest in future aerospace programs -- for example, Boeing's (NYSE:BA) possible launch of its New Midsize Airplane -- and future capital/restructuring requirements as well as the timing of costs for the United Technologies portfolio separation.
Since most of these events are likely to lead to an upgrade to future earnings prospects, it's reasonable to conclude that management is being conservative with guidance. Indeed, at the conference, Hayes spoke of "between $8 billion and $9 billion in 2021 of free cash flow coming out of the company."
In any case, whether you assume $8 billion, $9 billion, or $9.3 billion, it's a big improvement on the $6 billion forecast for the combined companies for 2019.
3. The merger with Raytheon is about strategic positioning
When United Technologies decided to spin off Otis (elevators) and Carrier (heating, ventilation, and air conditioning, or HVAC; and fire safety and security products), it also decided that the remaining company, made up of Collins Aerospace and Pratt & Whitney, would focus on commercial and defense aerospace.
That's fine, but the remaining aerospace company would also have $24 billion in debt, and investing in high-ticket items such as developing the geared turbofan is a costly enterprise.
However, as Hayes noted, there is "essentially zero debt coming from Raytheon" and, as we've already seen above, substantive amounts of cash flow set to be generated by both companies in the coming years. In addition, both companies can obviate the necessity of investing in technologies that they will already get from each other by being part of the same company.
All told, Raytheon's lack of debt and strong cash flows (the company is a leading stock in the defense sector) mean that a combination with the remaining United Technologies aerospace businesses will create a company with the ability to invest in new technologies in the way that a stand-alone United Technologies couldn't.
4. A spun-off Carrier is the most interesting company
It might seem strange to pick out Carrier, the weakest-performing segment of United Technologies (Hayes said its earnings would likely come in at the low end of full-year guidance), but it is possibly the company with the best chance of improvement after the spinoffs.
The logic behind the argument is that it appears that Carrier is being hamstrung by the focus on the other events at the company. Hayes openly discussed the possibility of some portfolio restructuring after the spinoffs, and this could include looking at the justification for Carrier to manage HVAC, fire safety, and security products in one company.
Furthermore, it's well known that the HVAC sector is ripe for consolidation, and Hayes said Carrier had been looking at doing a deal that was forgone, partly because it would have disrupted the timing of the spinoffs.
Bottom line: Expect significant restructuring and corporate activity at Carrier after the spinoff -- actions that could release value in the stock.
5. Buy Raytheon, not United Technologies
Another presentation, and another demonstration that United Technologies' aerospace businesses are outperforming its commercial businesses. So here's the thing: If you buy United Technologies stock, you are going to get a piece of the aerospace businesses (which will then merge with Raytheon), Carrier, and Otis. However, if you just buy Raytheon instead, you will get to own United Technologies' aerospace businesses (assuming the merger takes place) without Carrier and Otis.
If you are worried about the outlook for Otis and Carrier, or just one of them, then you would be better off just buying Raytheon and waiting for the merger to take place.