In this article, let's take a look at United Technologies Corp. (UTX, Financial), a $96.95 billion market cap company, a multi-industry holding company that conducts business through five segments: Otis; UTC Climate, Controls & Security; Pratt & Whitney; UTC Aerospace Systems and Sikorsky.
Defense sector
U.S. government sales represented about 20% of United’s revenues. This shows that cash flows are very sensitive to the Defense sector. For example, the company is developing three programs: the Joint Strike Fighter, Sikorsky's Black Hawk program, and the refueling tanker program with Boeing.
Cash flow generation
The company generates strong cash due to its profitable businesses, but it also focuses on raising operating margins. Strong cash flows are very important because they can allow the firm to invest in longer-term platforms.
Another important reason is that, since 1936, United has a policy showing its commitment to returning cash to investors in the form of dividends as it generates healthy cash flow on a regular basis. Although the current dividend yield is not too high, currently at 2.2%, it can improve in the future allowing higher shareholder returns.
Offsetting developed markets
With an exposure of almost 20%, we continue to believe that emerging markets are key regions because they allow United to remain profitable even during difficult economic times in developed markets. The firm is a dominant player in the elevator market in China, a country that has one-third of the world's elevators and is expected to increase much faster than U.S. domestic markets.
Some risks
More than 60% of its sales came from international markets, which means that United is exposed to currency risk. If we continue thinking about risks, we can highlight another risk: the cyclicality of construction and aerospace segments.
Revenues, margins and profitability
Looking at profitability, revenue grew by 4.56% led earnings per share increased in the most recent quarter compared to the same quarter a year ago by 31.6% ($2.03 vs $1.55). During the past fiscal year, the company increased its bottom line. It earned $6.22 versus $5.35 in the previous year. This year, Wall Street expects an improvement in earnings ($6.85 vs $6.22).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| UTX | UnitedTech | 19.33 |
| BA | Boeing | 38.95 |
| LLL | L-3 Communications Holdings Inc | 12.05 |
| LMT | Lockheed Martin Corp | 80.40 |
| Ă‚ | Industry Median | 7.63 |
The company has a current ROE of 19.33% which is higher than the one exhibit by L-3 Communications Holdings Inc. (LLL, Financial) and the industry median. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking at higher levels of ROE, Boeing (BA, Financial) could be the option. Lockheed Martin Corp (LMT, Financial) even has a much higher ratio. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 15.6x, trading at a discount compared to an average of 22.5x for the industry. To use another metric, its price-to-book ratio of 2.84x indicates a premium versus the industry average of 1.74x while the price-to-sales ratio of 1.49x is above the industry average of 1.0x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $17.586, which represents a 12.0% compound annual growth rate (CAGR).
Final comment
The global economy is showing signs of improvement and this should help the industrial sector. A weak global economic environment in developed economies plus a moderate growth in China and India, makes emerging markets as key drivers for future growth.
The management focuses on raising margin, and strategies are implemented in that sense. Further, key initiatives such as improving efficiency and technologies are efforts that soon will be rewarded.
Moreover, the stock's relative valuation and the return on equity that exceeds the industry average make me feel bullish on this stock.
Hedge fund gurus like Ruane Cunniff (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), John Burbank (Trades, Portfolio), Ken Fisher (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as Diamond Hill Capital (Trades, Portfolio).
Disclosure: Omar Venerio holds no position in any stocks mentioned
