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After Restructuring, Just Where Is United Technologies Corporation Heading?

By Lee Samaha - Sep 21, 2015 at 7:23PM

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The industrial conglomerate has had a difficult year in 2015 and there are question marks on its restructuring strategy.

Ever since the abrupt retirement of former CEO Louis Chenevert in November 2014, the market has speculated over the future strategic direction of United Technologies (RTX 0.38%). A change of CEO often means a change of direction, and given that the stock is down more than 18% this year, investors will be questioning whether CEO Gregory Hayes is taking the company on the right path. Let's take a closer look and try to answer this question.

United Technologies is selling Black Hawk manufacturer Sikorsky. Image source: Sikorsky website.

United Technologies' strategic direction
Earlier in the year I outlined United Technologies' growth strategy, arguing that there were three essential strands:

  • The sale of its military and commercial helicopter manufacturer Sikorsky.
  • The acquisition of a company within its core commercial aerospace and buildings operations, which Hayes previously outlined could be in the scale of $5 billion-plus.
  • Productivity improvements including corporate restructuring, cost synergy generation from integrating Goodrich, and cutting costs at UTC Aerospace Systems, or UTCAS.

It all makes perfect sense, and the good news is that the company has already agreed to sell the relatively low-margin Sikorsky business to Lockheed Martin while its productivity improvements are on track. A major acquisition hasn't been made yet, but with the stock market in decline in 2015, the company could end up paying a cheaper price for an acquisition than originally envisaged.

All told, the strategic plans are pretty much on track, so what went wrong in 2015?

Commercial aerospace aftermarket sales
At its second-quarter earnings presentation in June, the company was forced to lower full-year earnings expectations. EPS from continuing operations (excluding Sikorsky) is now expected to be in the range of $6.15 to $6.30, down from previous expectations of $6.35 of $6.55. The reasons are twofold: lower than previously expected commercial aftermarket sales in UTCAS and weak sales with Otis elevators in Europe and China. However, neither issue detracts from the rationale behind the strategic shift. In other words, I would argue that the company is still on the right track.

Commercial aftermarket sales are now expected to be slightly down in 2015 compared to a previous estimate of high-single-digit growth. The main problem area is in provisioning sales on Boeing's 787 airplanes. Provisioning makes up roughly 22% of UTCAS aftermarket sales with spare parts contributing around 33% and the rest coming from repair. Management had expected provisioning revenue to be up 10% in 2015, but it's now expected to decline by 10%, with Boeing 787 provisions expected to be down 40%.

Frankly, these issues are probably more a consequence of overoptimistic assumptions than any fundamental problem with end demand. Ultimately, airlines' inventory provisioning is a function of miles flown: The more miles an aircraft flies, the more the airline will need to replace parts and purchase more inventory in future. In addition, the main problem in 2015 appears to be largely limited to the 787.

Otis in Europe and China
The second issue is more of a macroeconomic concern, as management cited weakness in Otis' Europe service business and a slowing in China's construction market. On the earnings call, management downgraded full-year organic-sales-growth expectations for Otis to low-single digits from previous expectations of mid-single digits. As a consequence, Otis' constant currency profit is expected to be down $25 million to $75 million compared to its previous estimate of an increase of $100 million to $150 million.

What does it mean for investors?
Frankly, the reasons behind the lowering of guidance don't really reflect badly on management's shift in strategic direction. There is not a lot that management can do about airlines' provisioning decisions on the 787, and weakness in its Europe and China construction markets is obviously an exogenous factor.

All told, the company's growth strategy appears on track, but investors in the stock will just have to weather the storms of slowing end demand in some of United Technologies' end markets.

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