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United Technologies – Fairly Valued

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United Technologies (UTX) released its Q3 2018 results on October 23rd and provided an upward revision to its adjusted EPS for the full year.

Approvals from the EU Commission and from the U.S. Department of Justice re: Rockwell Collins acquisition have been received and feedback from China is anticipated within 2 - 6 weeks.

UTX's Board continues to evaluate strategic options for the company’s future and a decision is expected before the end of 2018. I anticipate the Board will recommend that one or two segments be spun-off or sold.

Summary

  • UTX released Q3 results on October 23 and provided an upward revision to its adjusted EPS for FY2018.
  • The Rockwell Collins acquisition has received approval from the EU Commission and from the U.S. Department of Justice.
  • The deal is currently under review in China and the acquisition is expected to close in 2 - 6 weeks.
  • UTX’s board continues to evaluate strategic options for the company’s future and a decision is expected before the end of 2018.

Introduction

Judging from the way stock prices have been behaving recently I suspect there are many nervous investors. Here are a few factors causing investor angst:

  • U.S. - China trade tensions;
  • Brexit;
  • Major financial challenges in Italy;
  • Worry about how higher interest rates could impact the US economy (the Federal Reserve has indicated a move to tighten up monetary policy by year’s end);
  • Uncertainty surrounding US mid-term elections.

Frankly, I have had my concerns for quite some time about what I have perceived to be lofty valuations. In many cases, the outcome of several of my analyses has been to ‘pass’ and to patiently sit on the sidelines.  A few of my calls have proven to be incorrect and I have watched the stock prices of some companies in which I have opted to ‘pass’ continue to rise in value.

Recently, however, I am pleased to see that several companies I perceived to be overvalued have been pulling back. Rather than fear a market pullback my outlook on market pullbacks is much like that of Buffett/Munger wherein they recommend investors be ‘fearful when others are greedy and greedy when others are fearful’.

This brings us to the subject of this article….United Technologies (NYSE: UTX). When I wrote my January 30th UTX article the stock was trading at ~$138. Based on my analysis I indicated that I would patiently wait for a pullback to a price of $130 or below.  UTX’s share price dropped below $130 in mid-March and drifted to as low as ~$115 (early May) but other investment opportunities arose and I did not add to my existing UTX position.

In mid-September, UTX’s share price rose to the ~$142 level. It has, however, has since pulled back to ~$128 (as I compose this article).

Given…

  • UTX’s reasonable valuation after this pullback;
  • my anticipation of some decent Q3 results (released October 23rd);
  • my positive long-term outlook on the company;

…I acquired another 300 shares @ ~$126 on October 22nd; these shares are held in one of the ‘side accounts’ of the FFJ Portfolio. For the sake of full disclosure I also own shares in undisclosed accounts which were acquired mid-April 2008.

The following are my thoughts as to why I decided to acquire additional UTX shares.

Overview

In my January 30th UTX article I indicated that UTX’s offer to acquire Rockwell Collins (NYSE: COL) had been overwhelmingly approved by COL shareholders. The rationale for this acquisition was to enable UTX to broaden its aerospace portfolio which is currently highly dependent on the geared turbofan engine.

In May 2018 the acquisition was approved by the EU Commission subject to conditions that included both companies divesting of certain operations. In order to mitigate regulators' concerns about reduced competition in the production of trimmable horizontal stabilizer actuators, certain pilot controls, pneumatic ice-wing protection and oxygen systems, both COL and UTX agreed to divest themselves of certain activities. COL had offered to divest its entire trimmable horizontal stabilizer actuator production and pilot-control business and its global business in ice protection while UTX had offered to divest two research projects in oxygen systems.

On October 2nd, the U.S. Department of Justice approved the sale of COL to UTX. This approval was granted on the condition that COL’s pneumatic ice protection systems business and its trimmable horizontal stabilizer actuator business be divested; COL already has a signed agreement to sell its actuators, pilot controls, and special products business to Safran, a French aerospace company. The sale is expected to finalize in the first half of 2019.

UTX’s management still requires necessary approvals from Chinese authorities but they are cautiously optimistic this approval will be received shortly.

While the closing of this transaction has taken longer than originally anticipated, work has been ongoing regarding the combining of the two entities. Based on the work done to date, UTX is confident that following the acquisition, UTX’s $30B business is likely to swell to $50B by ~2020. Furthermore, the UTX and COL teams have already identified $50 million in cost synergies.

In addition to the work going on regarding the merger of both companies, UTX’s board has continued to evaluate strategic options for the company’s future. Originally the thought was that UTX would begin to evaluate options once the COL deal had closed. UTX’s CEO, however, has indicated that UTX has not been waiting for the COL deal to close and that analysis has been ongoing for roughly the past year regarding a potential split up of UTX. Further details on this front are tentatively expected to be released before the end of 2018.

In my opinion, I envision that UTX will come to the decision that one or two segments of the company is/are to be spun off into totally independent publicly listed entity(ies), or sold, following the completion of the evaluation of strategic options for the company’s future. Proceeds would then likely be deployed toward the enhancement of the competitive position of the segments UTX has deemed to be core versus the repayment of debt.

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By |October 23rd, 2018|General Investing|Comments Off on United Technologies – Fairly Valued

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