Investors are entering the upcoming earnings season with a sense of nervous anticipation given the recent weakness in business survey data and a slew of companies reporting weak end-market conditions. That said, United Technologies (RTX 0.34%) -- a future merger partner for Raytheon (RTN) -- looks like an industrial giant that could report some relatively good news for the quarter and beyond.
United Technologies earnings preview
The company is set to split into three separate companies with the spin-offs of its Otis elevator unit and its Carrier HVAC business, followed by a merger of its remaining aerospace businesses (Collins Aerospace and Pratt & Whitney) with Raytheon.
Image source: Getty Images.
In this context, let's see what the third-quarter earnings report might have in store for the three future companies. Spoiler alert: It's a mixed bag.
Data source: United Technologies.
Aerospace is set to remain strong
There were plenty of investors and commentators who were skeptical that United Technologies could pull off the integration of Rockwell Collins, let alone take on the merger with Raytheon, but they have been proven wrong. In fact, the integration has gone better than initially planned, and United Technologies CEO Greg Hayes has been raising his estimate for the earnings accretion from the deal through 2019.
The table below shows how management has adjusted guidance as the year has progressed. You can see the positive impact on total company guidance (in July) by the hike in guidance from the accretion of Rockwell Collins. Moreover, at a recent investment conference, Hayes said that the EPS accretion would be "north" of the $0.50 currently forecast -- that's good news for investors and suggests some upward pressure on overall guidance.
|
United Technologies Full-Year Guidance |
July |
April |
January |
|---|---|---|---|
|
Total company adjusted EPS |
$7.90 to $8.05 |
$7.80 to $8 |
$7.70 to $8 |
|
EPS accretion from Rockwell Collins |
$0.50 |
$0.35 |
$0.35 |
|
Total company organic sales growth |
4% to 5% |
3% to 5% |
3% to 5% |
Data source: United Technologies. Figures in bold represent upgrades.
It's also good news because, at the same conference, Hayes specified that the upgrade to expectations was largely coming from strength in the commercial aerospace aftermarket in the legacy Collins business.
The commercial aftermarket has been an area of real strength in 2019. Management said that second-quarter commercial aftermarket sales in the Collins Aerospace unit were up 16%. There have been concerns that the recent slowing in the economy could filter though into a slowdown in aftermarket sales, but Hayes' recent commentary should give confidence going into the earnings report.
Carrier's margin performance
Frankly speaking, Carrier has been disappointing in recent years. The business comprises a mix of residential and commercial heating, ventilation, and air conditioning (HVAC) products; fire and security products, and transport and commercial refrigeration.
Indeed, Hayes lowered the full-year sales and earnings outlook in July on the back of weaker-than-expected orders in refrigeration and global HVAC end markets. The current guidance range for Carrier is for segment profit (excluding foreign exchange) to improve by $25 million to $75 million, down from an estimate of $125 million to $175 million in January, but at the recent conference Hayes said to expect earnings at the low end of the adjusted range.
Putting this together, don't be surprised if the Carrier segment guidance is lowered again.
On a more positive note, Carrier's adjusted operating margin was 17.5% in the second quarter -- the first quarter in over a year where margin improved. Given the drop in commodity prices in the last quarter, there's potential for Carrier to improve its profit margin and help offset weaker-than-expected sales.
Data source: United Technologies. 100 basis points equal 1%.
Otis in China
Having previously lost market share in the all-important China market, management decided to be more aggressive on new-equipment pricing in order to drive equipment orders -- not a bad thing considering that the big profit generator in elevators is the higher-margin aftermarket service revenue.
Data source: United Technologies.
As such, Otis has clearly made progress (see the chart above) even as weakness in European and North American orders have turned overall growth in new equipment orders negative. Otis' focus is on growing orders in China, and here there may be some good news -- even if it is just near term.
The latest business survey from China suggests some stabilization, not least due to infrastructure investments by the government. This might benefit Otis in the quarter and beyond, provided it proves sustainable.
Looking ahead
The aerospace businesses are likely to report a good quarter, but Carrier is set for a weak quarter, and investors will be hoping for some margin improvement to offset weak sales growth. It's anybody's guess how Otis' new equipment orders in China will develop over the mid-term.
On balance, United Technologies looks set for a good quarter, but ultimately its mid- to long-term prospects are likely to be guided by global economic growth and the resolution of the trade conflict. If the latter is in place, then United Technologies can outperform.
