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United Technologies Gains on Restructuring Moves, Costs High

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On Dec 31, we issued an updated research report on United Technologies Corporation (UTX - Free Report) . This Zacks Rank #3 (Hold) stock is poised to grow on the back of ongoing portfolio restructuring moves and stronger end-market sales. However, rising costs are a major concern.

Let’s delve into the aspects that are influencing the stock’s performance.

Favorable Factors

United Technologies expects that ramp up in military programs, increased global air traffic and high passenger load factor will boost upcoming quarterly results of the Aerospace business. Meanwhile, increased construction activity in the United States, higher infrastructure spending in China and greater urbanization rate in Asia is expected to enhance near-term performance of the Commercial Building business. Additionally, consistent demand growth in refrigeration and heating, ventilation and air conditioning (HVAC) end markets is likely to improve top-line performances in the upcoming quarters. The company currently expects to secure organic revenue growth of roughly 6% in 2018. Notably, review guidance for the year is currently pegged at $64.5-$65 billion, up from the prior view of $64-$64.5 billion. Per our estimates, United Technologies’ year over year revenue growth is currently pegged at 8.5% and 15.1% for 2018 and 2019, respectively.

Significant business buyouts are expected to heighten United Technologies’ competency, going forward. In this context, the acquisition of Rockwell Collins (inked in September 2017 and completed recently) is worth mentioning. This $30-billion buyout (closed on Nov 26) is expected to strengthen the company's product portfolio and enable it to launch innovative solutions for the aerospace customers. Notably, the acquisition is expected bring earnings accretion in the range of 15-20 cents in 2019 and generate cost synergies of more than $500 million by the fourth year of deal closure.

The company also believes that the new portfolio restructuring initiative will prove beneficial.  The recently acquired Rockwell Collins assets along with United Technologies’ UTC Aerospace Systems have formed a new unit — Collins Aerospace Systems. The unit will be a global leader in providing mechanical, electrical and software solution to the military as well as commercial aviation industry. Additionally, the company intends to divide its businesses into three independent companies — United Technologies, Otis and Carrier.

United Technologies pulled off a positive average earnings surprise of 8.23% in the past four quarters. The company anticipates that higher revenue growth, Rockwell Collins acquisition and greater operational efficacy will enable it to sustain earnings streak alive in the quarters ahead. The company expects to report adjusted earnings within the range of $7.10-$7.20 per share in 2018. Per our estimates, the company’s earnings per share are likely to rse 9.2% in the next three to five years.

Existing Issues

In spite of the aforementioned positives, we notice that United Technologies’ shares have declined 24.9% in the past three months compared with 20.1% fall of the industry.

Escalating costs, if not checked, will continue to weigh on profits. Material cost inflation (due to tariffs levied on U.S. imports) and higher logistics expenses might continue to increase cost and hurt the bottom line. Notably, United Technologies predicts that higher tariff rates will dent earnings by 5 cents per share and 15 cents per share in 2018 and 2019, respectively.

Moreover, weak business in Korea (third prime equipment market) and unfavourable foreign currency movements might continue to dent revenues in the Otis segment. Also, the company estimates that operating profit in the segment will dip nearly $75 million year over year in 2018. Ongoing pricing actions undertaken in new equipment and service businesses will fail to offset the segment’s near-term cost pressures.

We also notice that a stronger U.S. dollar might continue to hurt United Technologies’ overseas revenues and profitas. Notably, the company estimates that foreign exchange headwind will hurt segmental operating profits by nearly $100 million in 2019.

Stocks to Consider

A few better-ranked stocks within the same space are listed below:

Carlisle Companies Incorporated (CSL - Free Report) carries a Zacks Rank #2 (buy). The company pulled off a positive average earnings surprise of 11.90% in the past four quarters. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

Federal Signal Corporation (FSS - Free Report) holds a Zacks Rank of 2. The company posted positive average earnings surprise of 21.18% in the trailing four quarters.

Applied Industrial Technologies, Inc (AIT - Free Report) carries a Zacks Rank of 2. The company delivered a positive average earnings surprise of 11.67% in the preceding four quarters.

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