The coming few years are likely to be an eventful period for investors in United Technologies Corporation (NYSE:UTX). As readers already know, management recently reaffirmed some of the key long-term objectives for the company. However, as discussed in the linked article, just hitting some of these objectives seems to require a major acquisition, and new CEO, Greg Hayes, is believed to be looking at potential targets.
Meanwhile, some Wall Street analysts believe that the company can enhance shareholder value by divesting its Sikorsky helicopter unit, or splitting the company's aviation and construction activities up. In this context, let's take a look at which segment is most productive for United Technologies Corporation, and what it could mean for its strategic direction.
Segmental return on assets
Looking at segmental return on assets, or ROA -- rather than segmental operating margin -- is arguably a better way to measure productivity. For example, company A can have a segment with a high-operating profit margin; but if the same amount of profit is produced by company B, which requires fewer assets to do so than A, then company B is more attractive -- even if its profit margin is lower.
First of all, in order to quickly gauge the importance of each segment, here's a breakout of operating profits:
Here is a look at segmental profit margin for United Technologies in the last few years:
Clearly, elevator and escalator manufacturer Otis is the highest-margin segment, with Sikorsky lagging, and the other three generating mid-teens margins. However, a look at ROA puts a different slant on the company.
A key conclusion for each segment
First, Otis is easily the most productive segment, and the good news is that management is expecting mid-single-digit sales growth in 2015 for the segment. On a less-positive note, there are question marks around the outlook for construction growth in Europe and China in 2015.
Second, management is targeting 20% operating margins for UTC Climate, Controls & Security by 2020 -- an event likely to increase ROA for the segment in future years.
Third, Pratt & Whitney has strong long-term growth prospects through generating adoption of its geared turbofan engine on regional aircraft, Bombardier's C-Series, and the Airbus A320neo. However, Pratt & Whitney's operating profit is expected to be lower by $25 million to $100 million in 2015 due to dealing with the initial ramp-up of orders for the engines. On a more positive note, its ROA should increase in future years as it starts to see payback for the initial investment in the engine.
Fourth, readers have already seen how the 2012 acquisition of Goodrich affected productivity at United Technologies -- now part of UTC Aerospace Systems. However, management expects cost synergies from the Goodrich acquisition to reach $400 million in 2014 and $500 million in 2015 -- ROA should increase notably. Indeed, adjusted operating profit was up 15% for UTC Aerospace Systems in the first nine months of 2014.
Fifth, despite declining operating margin and ROA, Sikorsky's ROA is still at a healthy level -- segment operating profit was down only 6% in the first nine months of 2014.
What does it all mean for United Technologies Corporation?
The idea of selling Sikorsky doesn't look like a no-brainer. Its ROA is still healthy, and management even might be tempted to make an acquisition of a company like Textron in order to generate growth. Indeed, Hayes clearly stated, "We are not going to sell Sikorsky" at the recent investor day in December.
Moreover, splitting the company into aerospace- and construction-focused companies doesn't look like an obvious choice, either. Many companies split up because the separate parts constitute starkly differing investment propositions. For example, one part could be a low-growth cash cow, while the other part could be an investment-hungry growth proposition.
However, the propulsion and aerospace segments look headed for a mix of strong growth (Pratt & Whitney) and cost-cutting synergy generation (UTC Aerospace Systems). Meanwhile, the building & industrial systems segments combine a high ROA/high cash-generating segment (Otis) with another segment (UTC Climate, Controls & Security), which looks set for a strong change in margin growth in the coming years.
In a nutshell, an ROA analysis of the company doesn't easily conclude that the company should be split up. Indeed, investors shouldn't be surprised if management decides to make an acquisition this year.