New England was "hunkering down" today and bracing to endure a snowstorm of "historic" proportions, but for one company it may already be too late to avoid the blizzard of bad news.
Early Monday morning, United Technologies (NYSE:UTX) warned analysts that "due to inclement weather," it was moving up its Q4 2014 earnings release. Instead of announcing earnings Tuesday, as had been planned, UTC reported its final 2014 numbers last night. Unfortunately for investors, the news-come-early was not unqualifiedly great.
For fiscal 2014, UTC reported:
- Sales growth of 4% to $65.1 billion (slightly ahead of the most recent forecast)
- Earnings growth of 10% to $6.82 per share (likewise)
- This was despite operating profit margins falling 10 basis points to 15.2%.
So far, so good. Now here's where things start to go bad. Free cash flow for fiscal 2014 was only $5.6 billion, 10% below reported net income. And heading into the new year, UTC is already walking back projections for fiscal 2015 revenue and profits -- backtracking on promises made just a month and a half ago. Specifically:
- Sales are now expected to run between $65 billion and $66 billion, not the $66 billion to $67 billion promised in December.
- Profits are likely to come in closer to $6.85 per share than to the $7.05 per share previously predicted.
- And with capital expenditures slated to approximate $1.7 billion in 2015 (level with 2014 capex), free cash flow will probably fall short of reported net income for the third year in a row.
According to S&P Capital IQ's historical data, UTC hasn't experienced such a long string of back-to-back-to-back weak free-cash-flow years in at least a decade. So, what's behind UTC's weakness? Perversely, it's the U.S. dollar's strength.
Commenting on the revised expectations Monday, UTC CEO Gregory Hayes said the global economy has been "slower than expected" lately. That hasn't slowed UTC down yet, with earnings still outpacing revenue growth through 2014. But what might slow it is "the continuing strengthening of the U.S. dollar."
Why a strong U.S. dollar is bad for United Technologies
As the U.S. dollar strengthens relative to foreign currencies, those foreign currencies necessarily weaken relative to the USD. This has two effects on UTC's business (neither of them good). On one hand, as their currencies weaken, foreign customers must spend more and more of their own currency to buy a given unit of goods and services from UTC. This effectively raises the price of UTC's products, making it hard to make a sale. On the other hand, when a sale does happen and UTC receives payment for its products in foreign currency, it must convert those payments back into U.S. dollars to calculate its profits. The foreign currency, however, buys fewer dollars -- reducing profits per sale. So it's really a double whammy for UTC.
How bad is this for United Technologies?
So, just how big of a whammy are we talking about? It depends on which currency you're measuring the dollar against. But one answer is that the U.S. dollar has increased in value relative to the euro by about 23% since early May 2014, while the euro has lost 18.5% of its value relative to the dollar. You can see the two trends here:
What does it mean for investors?
At a current valuation of 17 times earnings, earnings growth projected at 10.5% annualized over the next five years, and paying a 2% dividend yield, United Technologies shares already look pretty expensive. They're likely to look more so if the dollar continues to strengthen over the course of this year -- making UTC shares look increasingly expensive.
This isn't a problem limited only to United Technologies, of course. But it is a big problem for United Technologies, which, according to S&P Capital IQ data, gets about 62% of its sales from outside U.S. borders. It's also a problem we'll be watching closely as earnings season rolls along and other large U.S. exporters report their results.