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Here's Why United Technologies Rocketed Higher in 2019

By Lee Samaha - Jan 13, 2020 at 10:14AM

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The company's strategic plans have received a warm welcome, and the stock remains attractive.

What happened

Shares in industrial conglomerate United Technologies (RTX -0.19%) rose 40.6% in 2019, according to data provided by S&P Global Market Intelligence. There are two reasons for the increase: operational performance and the announcement of a deal to merge the aerospace business (Pratt & Whitney and Collins Aerospace) with defense company Raytheon (RTN). I'll briefly discuss both in turn.

It's been a mixed year for this large and diverse company. A look back at its third-quarter earnings report shows that the aerospace businesses have outperformed in 2019. Pratt & Whitney is on track to do slightly better than management expected at the start of the year, and Collins Aerospace has outperformed due to a buoyant aerospace market (aftermarket, defense, and original equipment) and the successful integration of the Rockwell Collins acquisition.

The cabin of a commercial airplane.

United Technologies makes a wide range of aviation solutions, ranging from engines to avionics, landing gear, and even interiors. Image source: Getty Images.

So what

The elevators business, Otis, is doing slightly better than management originally expected at the start of the year, and the company appears to be growing new equipment orders again in the crucial China market -- a key part of its plan to win market share and then generate highly profitable services revenue over the long term.

The one major disappointment has come from Carrier (air conditioning, fire security, and safety products), where management has shifted the midpoint of its full-year operating profit guidance from an increase of $125 million (given in January) to a decline of $125 million (updated in October) due to weakness in transport refrigeration and residential heating, ventilation, and air conditioning.

Frankly, Carrier has underperformed its peers on a revenue and margin basis for a while, and there's a case for arguing that it could be the biggest beneficiary of the plan to split United Technologies up into three companies -- the aerospace business will merge with Raytheon after Otis and Carrier are separately spun off.

Turning to the plan to merge the aerospace businesses with Raytheon, it appears that the market has warmed to the idea. This was no easy task for management to accomplish after hedge funds began bleating about it after it was announced. If the stock price is the ultimate arbiter, it seems that United Technologies management was right and the hedge funds were wrong.

Moreover, despite the rise, the market still appears to be undervaluing the proposed deal. You can get an idea of how the market is valuing the proposed new company, to be called Raytheon Technologies, by looking at Raytheon's current market valuation. An analysis of the deal suggests that the market is still undervaluing "Raytheon Technologies" relative to its peer group, and consequently, both stocks look like a good value.

Now what

Investors will be hoping for a smooth 2020 as Otis and Carrier are spun off and the Raytheon merger then takes place. United Technologies management has a good track record of integrating major companies -- Goodrich and Rockwell Collins are both outperforming management's initial targets for cost savings -- and investors can look forward to the creation of Raytheon Technologies with a sense of optimism.

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