Over the past 52 weeks, United Technologies (UTX 1.67%) stock has improved in price by less than 1%. That's about 18 times worse than the performance of the average stock on the S&P 500.
But does United Technologies deserve to be scorned by investors? Is business really so bad? And what is management doing to dig its stock out of its slump and to grow the business?
To find out, we listened in on United Technologies' recent second-quarter earnings conference call -- and are here to report back to you on its five most important revelations. All quotes are from CFO Gregory Hayes.
Marine 1 in flight. Photo: Wikimedia Commons.
Sikorsky is on Cloud 9
Sikorsky [was] selected on two key U.S. DOD programs in the quarter ... to build the next generation Marine 1 presidential helicopter and to develop new combat search-and-rescue helicopters for the U.S. Air Force. Combined, these two programs represent over $12 billion of future sales opportunity.
One big reason for United Technologies' stock underperformance is that the company has struggled to provide Canada's military with a fleet of 28 Cyclone maritime helicopters on time and up to spec. This has necessitated multiple charges to earnings at UTC over the past couple years (the helicopters were initially supposed to have been delivered in 2011). But as Hayes pointed out, the news isn't all bad at Sikorsky -- far from it.
The Marine 1 contract, awarded in May, will bring Sikorsky $1.24 billion in high-margin revenue for the initial flight of six specially outfitted S-92 helicopters. A conservative estimate of the revenue to be derived from building 15 additional Marine 1 helicopters puts the total contract value at anywhere from $1.5 billion to $4.3 billion.
The numbers for the combat rescue helicopter, or CRH, program start out similarly with an initial award of $1.28 billion to begin developing a replacement for the Air Force's fleet of HH-60G Pave Hawk CRH helicopters. As the entire fleet of 112 helos gets built out, the program is likely to swell to $7.9 billion or more. So Sikorsky in all seems to be doing all right, Canada notwithstanding.
Otis Elevator is (more than) pulling its weight
In the Americas [sales showed] 15% growth in Otis. In Europe ... the economic recovery remains tepid, [but] commercial sales grew ... 15%. ... North American new equipment orders [at Otis] were up 44%. ... Otis' new equipment orders were up 10% led by strong growth in eastern Europe, where orders were up more than 20%.
Hayes threw out a lot of numbers there, but the upshot is this: Sales are accelerating at Otis Elevator, rising 7% year over year in the second quarter, and the rapid increase in new orders from North America promises continued sales growth. When you consider further that Otis is United Technologies' most profitable division, earning an operating profit margin in excess of 20% last quarter, this is inarguably good news for the stock.
Strong performance at Otis is one reason management felt confident raising its earnings guidance for full-year 2014 to a new target of $6.75 to $6.85 per share.
50% market share in plane engines
In response to a question about orders received at the Farnborough International Airshow: "It was a big air show. ... We've got right now about 6,200 engines, I think, on order ... and we've got just about 50% market share. ... At the end of the day, I think the market will decide which technology is best, [but we think UTC's engines are] going to outperform the Leap in the marketplace, and that will ultimately be the determinant of what the market share is.
There's a fierce battle underway between United Technologies and its Pratt & Whitney geared turbofan jet engine and rival General Electric (NYSE: GE) with its Leap-X engine. Both companies are marketing their new engines to companies including Boeing, Airbus, and Embraer as more fuel-efficient than previous generations of engines. Both companies want to win as big a share of the market for these new engines -- estimated at $500 billion over the next decade -- as possible.
So far, UTC seems to be holding its own in this contest. With $250 billion as the ultimate reward for maintaining market share -- and billions more revenue potentially if the geared turbofan can win sales from its rival -- this is good news for owners of United Technologies stock.
Free cash is falling short
As you know, at UTC we typically deliver free cash flow greater than or equal to net income. Through the first half, free cash flow is 81% of net income and cash flow is generally stronger in the second half; but as I sit here today, I think 90% to 100% for 2014 is more realistic based on the continued investments we're making on the aerospace side to deal with the aerospace cycle.
Here, then, is where the bad news starts to filter in. The capital investment required to ramp up production capacity to build all these new engines is eating into free cash flow at United Technologies, and depriving the stock of one of its historically strongest selling points: the sure knowledge that UTC's net profit figures are all they're cracked up to be -- because they've always been backed up with plenty of cold, hard cash.
That Hayes could not promise a quick return to full 100%-of-net profit free cash flow even through the next six months may cause investors some consternation.
What to expect next
I think capex definitely peaks this year just shy of $2 billion -- that's up from about $1.7 billion last year, and then next year we'll see that come down $200 million, $300 million again as the ramp, or the facilitization for the ramp is pretty much complete by next year. Again, we're going to start delivering these engines at the end of next year and we have to be ready, so the money is going out now. ... We'll continue to target 100% of free cash flow to net income both this year and next year. I think we're just acknowledging now that it's going to be really difficult to do it this year.
But even if United Technologies can't return free cash flow to historical norms right away, if investors will show just a little bit of patience, Hayes said the company will get there eventually.
Indeed, capital spending will begin to moderate as early as next year, returning to perhaps 2013 levels. And while Hayes seemed confident that this will produce free cash flow equal to (or better than?) net income next year, he also hinted that Untied Technologies might surprise us and produce strong free cash flow as early as later this year.
If he's right, then the warning about "90% to 100%" could actually be a lowball prediction. Hayes could be setting up investors for a positive surprise later in 2014. At least, United Technologies stockholders can hope that's the implication.
And just knowing that this is a possibility is probably worth the price of admission to listening in on United Technologies stock's conference call. And lucky you -- you didn't even have to!
