Report created Dec 29, 2011 Page 1 OF 5 United Technologies is an aerospace-industrial conglomerate whose portfolio includes Climate Control & Security (which now combines UTC Fire Security with Carrier), Pratt & Whitney jet engines, Sikorsky helicopters, Otis elevators, Carrier air conditioners and Hamilton Sundstrand aerospace and industrial products. In 2010, revenues surpassed $54 billion. Analyst's Notes Analysis by John Staszak, CFA, December 28, 2011 ARGUS RATING: HOLD Downgrading to HOLD on mixed prospects for 2012 Increased commodity prices and higher other costs are likely to restrain earnings somewhat over the next several quarters. In particular, we expect higher engineering and development (E&D) and pension expense to pressure earnings. Unfavorable foreign currency translations are also likely to hurt results. We expect flat or lower revenue at two of the company's five divisions (Sikorsky and Climate Control & Security). We expect UTX's operating margin to deteriorate going forward. We are maintaining our 2011 EPS estimate of $5.50 but lowering our 2012 estimate from $6.20 to $6.00. Our long-term rating remains BUY. Based on the company's earnings momentum, demonstrated ability to execute its growth plans, and improving margins, we project long-term EPS growth of 12% annually over the next five years. INVESTMENT THESIS We are downgrading United Technologies Corp. (NYSE: UTX) from BUY to HOLD. Increased commodity prices and higher other costs are likely to restrain earnings over the next several quarters. In particular, we expect higher engineering and development (E&D) and pension expense to pressure earnings. Unfavorable foreign currency translations are also likely to hurt results. We expect flat or lower revenue at two of the company's five divisions (Sikorsky and Climate Control & Security). Our long-term rating remains BUY. Based on the company's earnings momentum, demonstrated ability to execute its growth plans, and improving margins, we project long-term EPS growth of 12% annually over the next five years. RECENT DEVELOPMENTS In mid-december, United Technologies reaffirmed its 2011 EPS estimate of $5.47 and provided 2012 guidance of $5.80-$6.00, excluding the Goodrich acquisition. (In late September, UTX agreed to acquire Goodrich for $18.4 billion, including debt of $1.9 billion, or $127.50 per share.) In 2012, management projects 2%-4% organic growth and Data Pricing reflects previous trading week's closing price. 200-Day Moving Average Price ($) Rating EPS ($) 75 50 52 Week High: $91.83 52 Week Low: $66.87 Closed at $83.97 on 2/24 Quarterly 0.78 1.05 1.14 1.15 0.93 1.20 1.30 1.31 1.11 1.45 1.47 1.47 1.25 1.48 1.57 1.70 Annual 4.12 4.74 5.50 ( Estimate) 6.00 ( Estimate) Revenue ($ in Bil.) Quarterly 12.2 13.2 13.4 14.2 12.1 13.9 13.5 14.9 13.3 15.1 14.8 15.5 13.2 14.3 15.5 16.3 Annual 53.0 54.3 58.7 ( Estimate) 59.2 ( Estimate) FY ends Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Dec 31 2009 2010 2011 2012 BUY HOLD SELL Argus Recommendations Twelve Month Rating SELL HOLD BUY Five Year Rating SELL HOLD BUY Rating Weight Under Over Weight Weight Argus assigns a 12-month BUY, HOLD, or SELL rating to each stock under coverage. BUY-rated stocks are expected to outperform the market (the benchmark S&P 500 Index) on a risk-adjusted basis over the next year. HOLD-rated stocks are expected to perform in line with the market. SELL-rated stocks are expected to underperform the market on a risk-adjusted basis. The distribution of ratings across Argus' entire company universe is: 46% Buy, 49% Hold, 5% Sell. Key Statistics Key Statistics pricing data reflects previous trading day's closing price. Other applicable data are trailing 12-months unless otherwise specified Overview Price $73.13 Target Price -- 52 Week Price Range $66.87 to $91.83 Shares Outstanding 906.09 Million Dividend $1.92 Overview Industrials Rating MARKET WEIGHT Total % of S&P 500 Cap. 10.00% Financial Strength Financial Strength Rating MEDIUM-HIGH Debt/Capital Ratio 31.2% Return on Equity 22.1% Net Margin 8.4% Payout Ratio 0.34 Current Ratio 1.33 Revenue $58.09 Billion After-Tax Income $4.85 Billion Valuation Current FY P/E 13.30 Prior FY P/E 15.43 Price/Sales 1.14 Price/Book 2.93 Book Value/Share $24.93 Capitalization $66.26 Billion Forecasted Growth 1 Year EPS Growth Forecast 16.03% 5 Year EPS Growth Forecast 12.00% 1 Year Dividend Growth Forecast 9.41% Risk Beta 1.10 Institutional Ownership 81.82%
Report created Dec 29, 2011 Page 2 OF 5 Analyst's Notes...Continued revenue of $59-$60 billion. As discussed in a previous note, UTX reported 3Q11 adjusted EPS of $1.47, up 12.6% year-over-year. The result was $0.02 above the consensus forecast and $0.05 above our estimate. The better-than-expected operating earnings reflected organic growth in all six of the company's divisions (for the second time since the second quarter of 2008.) Favorable foreign currency translation and one-time gains benefited earnings, while restructuring charges and a higher tax rate hindered results. Consolidated revenues came to $14.8 billion, up 8.7% from 3Q10, reflecting strong results at Sikorsky and Otis. Primarily reflecting 31.9% higher operating profit at Sikorsky, operating profit rose 14.6% to $2.3 billion. The operating margin increased 70 basis points to 14.9% on significantly higher margins at Carrier, Hamilton & Sundstrand and Sikorsky. Interest expense continued to decrease, declining 14.3% to $138 million. The diluted share count decreased modestly to 902 million as UTX repurchased $675 million of its stock during the quarter, less than 2Q11 but more than the $556 million spent on repurchases in 4Q10. EARNINGS & GROWTH ANALYSIS We continue to expect the company to report solid earnings growth in 2011. As 3Q11 ended, UTX's order book remained strong, with management raising guidance a fourth time this year. We think the company can achieve strong revenue growth over the remainder of the year. By division, Otis should see solid top-line gains (up 8.7% in 3Q11) due to higher service revenues and improved demand in North America. Otis is also likely to see revenue increase significantly in international markets and China. In addition, strong sales are likely at Carrier as sales of refrigerated containers and HVAC grow at double-digit rates. (Revenue was up 21% in 3Q11.) Among the company's aerospace divisions, Pratt & Whitney appears likely to post the most significant improvement in earnings in 2011. Pratt & Whitney and Hamilton Sundstrand have reported strong growth in orders for spare parts for aircraft, and Hamilton Sundstrand's industrial businesses are also likely to report strong earnings. As such, we are leaving our 2011 EPS estimate at $5.50. Driven by such emerging markets as China and India, management said it expects the global economy to grow by nearly 3.0% in 2012. However, management said prospects for margins are mixed. Except for Climate Controls & Security and Sikorsky, management expects all of the company's business divisions to report higher revenue. At Climate Controls & Security, we are lowering our growth revenue estimate from 2% to up slightly as divestitures offset organic growth. Operating profit, we believe, is likely to improve significantly as management achieves operating efficiencies at the company's disparate security businesses. At Sikorsky, we now see 5% lower revenue, versus our earlier estimate for a 3% decline. Operating profit at Sikorsky is likely to rise Growth & Valuation Analysis GROWTH ANALYSIS ($ in Millions, except per share data) 2007 2008 2009 2010 2011 Revenue 54,759 59,757 52,425 54,326 COGS 39,922 43,637 38,861 39,414 Gross Profit 14,837 16,120 13,564 14,912 SG&A 6,109 6,724 6,036 6,024 R&D 1,678 1,771 1,558 1,746 Operating Income 7,050 7,625 6,377 7,186 Interest Expense 666 689 617 648 Pretax Income 6,384 6,936 5,760 6,538 Income Taxes 1,836 1,883 1,581 1,827 Tax Rate (%) 29 27 27 28 Net Income 4,224 4,689 3,829 4,373 Diluted Shares Outstanding 989 956 929 923 EPS 4.27 4.90 4.12 4.74 Dividend 1.17 1.35 1.54 1.70 GROWTH RATES (%) Revenue 12.7 9.6-11.3 3.6 Operating Income 15.6 8.2-16.4 12.7 Net Income 13.2 11.0-18.3 14.2 EPS 15.1 14.8-15.9 15.0 Dividend 15.3 15.0 14.5 10.4 Sustainable Growth Rate 15.9 18.3 13.3 13.5 14.6 VALUATION ANALYSIS Price: High $82.50 $77.14 $70.89 $79.70 $91.83 Price: Low $61.85 $41.76 $37.40 $62.88 $66.87 Price/Sales: High-Low 1.5-1.1 1.2-0.7 1.3-0.7 1.4-1.1 - P/E: High-Low 19.3-14.5 15.7-8.5 17.2-9.1 16.8-13.3 - Price/Cash Flow: High-Low 15.3-11.5 12.0-6.5 12.3-6.5 12.5-9.8 13.4-9.7 Financial & Risk Analysis FINANCIAL STRENGTH 2009 2010 2011 Cash ($ in Millions) 4,449 4,083 Working Capital ($ in Millions) 5,281 5,778 Current Ratio 1.29 1.33 LT Debt/Equity Ratio (%) 41.1 46.8 Total Debt/Equity Ratio (%) 48.6 48.1 RATIOS (%) Gross Profit Margin 25.9 27.4 Operating Margin 12.2 13.2 Net Margin 7.3 8.0 Return On Assets 6.8 7.7 Return On Equity 21.4 21.1 RISK ANALYSIS Cash Cycle (days) 88.9 83.6 Cash Flow/Cap Ex Oper. Income/Int. Exp. (ratio) 9.2 9.7 Payout Ratio 27.5 37.4 35.9 The data contained on this page of this report has been provided by Morningstar, Inc. ( 2012 Morningstar, Inc. All Rights Reserved). This data (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. This data is set forth herein for historical reference only and is not necessarily used in Argus analysis of the stock set forth on this page of this report or any other stock or other security. All earnings figures are in GAAP.
Report created Dec 29, 2011 Page 3 OF 5 Analyst's Notes...Continued modestly as management works toward increasing the operating profit margin to 14%. Elsewhere, we expect Pratt Whitney and Hamilton Sundstrand to report 8%-10% higher revenue. At Pratt & Whitney, however, we project a lower operating profit as the company invests in growth initiatives and pension expense increases. We expect Hamilton Sundstrand to benefit from strong sales of its industrial products, as well as aftermarket sales of parts and services to the commercial aerospace industry. We also think this division will benefit from increased production of Boeing's 787 Dreamliner. At Otis, we project 5% revenue growth but only modestly higher operating profit as a result of unfavorable foreign currency translations. Overall though, we believe our margin projections were somewhat optimistic and we are reducing our 2012 earnings estimate from $6.20 to $6.00 per share. We expect UTX to use a part of its strong cash flow for acquisitions, but are excluding these from our projections. Our five-year earnings growth rate forecast remains 12%. FINANCIAL STRENGTH & DIVIDEND Our financial strength rating for UTX remains Medium-High, the second-highest rank on our five-point scale. Reflecting strong operating cash flow, free cash flow totaled $1.7 billion in the third quarter, above our estimate of $1.5 billion. The debt/cap ratio was 33% at the end of 3Q11, up 100 basis points from the end of 2010. UTX pays a quarterly dividend of $0.48 per share, or $1.92 annually, for a yield of about 2.6%. Our 2011 and 2012 dividend estimates are $1.86 and $2.08, respectively. MANAGEMENT & RISKS UTX benefits from the global diversity of its markets and business segments, which helps to offset weakness in any particular area. The domestic U.S. housing market remains a challenge for Carrier, but it represents a minimal portion of UTX's worldwide revenues. Over 60% of revenues are generated outside the U.S., creating significant exchange rate risk. As a defense contractor, the company is subject to possible shifts in defense spending or the loss of a large military contract. COMPANY DESCRIPTION United Technologies is an aerospace-industrial conglomerate whose portfolio includes Climate Control & Security (which now combines UTC Fire Security with Carrier), Pratt & Whitney jet engines, Sikorsky helicopters, Otis elevators, Carrier air conditioners and Hamilton Sundstrand aerospace and industrial products. In 2010, revenues surpassed $54 billion. VALUATION UTX shares have traded in a range of $67-$92 over the past 52 weeks and are currently trading toward the low end of this range. The shares trade at approximately 13.3-times our 2011 EPS estimate and at 12.2-times our 2012 estimate, compared to a five-year average multiple of 16.1. We believe the shares adequately Peer & Industry Analysis The graphics in this section are designed to allow investors to compare UTX versus its industry peers, the broader sector, and the market as a whole, as defined by the Argus Universe of Coverage. The scatterplot shows how UTX stacks up versus its peers on two key characteristics: long-term growth and value. In general, companies in the lower left-hand corner are more value-oriented, while those in the upper right-hand corner are more growth-oriented. The table builds on the scatterplot by displaying more financial information. The bar charts on the right take the analysis two steps further, by broadening the comparison groups into the sector level and the market as a whole. This tool is designed to help investors understand how UTX might fit into or modify a diversified portfolio. P/E 15 10 SI DE Value 5-yr Growth Rate(%) TYC MMM HON EMR ITW UTX 7.5 10 12.5 15 Growth 5-yr Net 1-yr EPS Cap Growth Current Margin Growth Argus Ticker Company ($ in Millions) Rate (%) FY P/E (%) (%) Rating SI Siemens AG 81,900 6.0 7.7 8.1 5.9 BUY UTX United Technologies Corp 66,262 12.0 13.3 8.4 9.1 HOLD MMM 3M Co 56,874 12.0 13.7 14.6 11.5 HOLD HON Honeywell International Inc 41,753 11.0 13.4 7.6 13.9 BUY EMR Emerson Electric Co 33,558 12.0 12.3 10.2 10.8 HOLD DHR Danaher Corp 32,155 15.0 16.4 13.7 18.9 BUY DE Deere & Co 31,085 7.0 9.9 8.9 7.1 BUY TYC Tyco International Ltd 22,645 9.0 12.8 10.0 12.9 HOLD ITW Illinois Tool Works Inc 22,425 12.0 12.2 11.4 18.4 HOLD Peer Average 43,184 10.7 12.4 10.3 12.0 DHR P/E Price/Sales Price/Book PEG 5 Year Growth Debt/Capital
Analyst's Notes...Continued reflect near-term prospects for less robust earnings growth attributable to commodity price inflation and increased pension expense. Should management eliminate more costs than we expect or costs moderate more than anticipated, we consider an upgrade. On December 28, HOLD-rated UTX closed at $73.13, down $0.90. NYSE: UTX Report created Dec 29, 2011 Page 4 OF 5
METHODOLOGY & DISCLAIMERS Report created Dec 29, 2011 Page 5 OF 5 About Argus Argus Research, founded by Economist Harold Dorsey in 1934, has built a top-down, fundamental system that is used by Argus analysts. This six-point system includes Industry Analysis, Growth Analysis, Financial Strength Analysis, Management Assessment, Risk Analysis and Valuation Analysis. Utilizing forecasts from Argus Economist, the Industry Analysis identifies industries expected to perform well over the next one-to-two years. The Growth Analysis generates proprietary estimates for companies under coverage. In the Financial Strength Analysis, analysts study ratios to understand profitability, liquidity and capital structure. During the Management Assessment, analysts meet with and familiarize themselves with the processes of corporate management teams. Quantitative trends and qualitative threats are assessed under the Risk Analysis. And finally, Argus Valuation Analysis model integrates a historical ratio matrix, discounted cash flow modeling, and peer comparison. THE ARGUS RESEARCH RATING SYSTEM Argus uses three ratings for stocks: BUY, HOLD, and SELL. Stocks are rated relative to a benchmark, the S&P 500. A BUY-rated stock is expected to outperform the S&P 500 on a risk-adjusted basis over a 12-month period. To make this determination, Argus Analysts set target prices, use beta as the measure of risk, and compare expected risk-adjusted stock returns to the S&P 500 forecasts set by the Argus Strategist. A HOLD-rated stock is expected to perform in line with the S&P 500. A SELL-rated stock is expected to underperform the S&P 500. Argus Research Disclaimer Argus Research is an independent investment research provider and is not a member of the FINRA or the SIPC. Argus Research is not a registered broker dealer and does not have investment banking operations. The Argus trademark, service mark and logo are the intellectual property of Argus Group Inc. The information contained in this research report is produced and copyrighted by Argus, and any unauthorized use, duplication, redistribution or disclosure is prohibited by law and can result in prosecution. The content of this report may be derived from Argus research reports, notes, or analyses. The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but Argus makes no representation as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. This report is not an offer to sell or a solicitation of an offer to buy any security. The information and material presented in this report are for general information only and do not specifically address individual investment objectives, financial situations or the particular needs of any specific person who may receive this report. Investing in any security or investment strategies discussed may not be suitable for you and it is recommended that you consult an independent investment advisor. Nothing in this report constitutes individual investment, legal or tax advice. Argus may issue or may have issued other reports that are inconsistent with or may reach different conclusions than those represented in this report, and all opinions are reflective of judgments made on the original date of publication. Argus is under no obligation to ensure that other reports are brought to the attention of any recipient of this report. Argus shall accept no liability for any loss arising from the use of this report, nor shall Argus treat all recipients of this report as customers simply by virtue of their receipt of this material. Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance. Argus has provided independent research since 1934. Argus officers, employees, agents and/or affiliates may have positions in stocks discussed in this report. No Argus officers, employees, agents and/or affiliates may serve as officers or directors of covered companies, or may own more than one percent of a covered company s stock. Morningstar Disclaimer 2012 Morningstar, Inc. All Rights Reserved. Certain financial information included in this report: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.