Apr 25 2014, 12:58pm CDT | by Forbes
United Technologies‘s first quarter earnings were impacted by restructuring charges, which more than offset the strong organic growth in its sales. The industrial conglomerate’s earnings fell by 5% annually to $1.32 per share despite a 5% organic growth in its sales. In our view, though these restructuring charges impacted the company’s first quarter earnings, they will be beneficial over the long term, as they will help expand the company’s operating margins making it more competitive. In the first quarter, excluding the impact from these restructuring activities which included headcount reductions, plant closures and consolidations, United Technologies’s earnings rose by 10% annually.
Growth in the company’s first quarter sales was driven by the global commercial aviation sector and the U.S. housing market, partially offset by a weak U.S. military market. With the war in Afghanistan coming to an end, demand for new military equipment as well as service of existing equipment from the U.S. government is falling. This is weighing on sales of UTC”s aerospace segments namely Pratt & Whitney, UTC Aerospace Systems and Sikorsky. However, sales across these three UTC segments rose in the first quarter due to growth from the global commercial aviation market offsetting the weak demand from the U.S. military.
Driven by healthy growth in its organic sales, the company also reaffirmed its 2014 sales guidance of $64 billion. Cost reductions achieved through restructuring activities also propelled UTC to raise the lower end of its 2014 earnings guidance. The company now expects 2014 earnings of $6.65-6.85 per share, up from $6.55-6.85 per share it expected earlier.
We currently have a stock price estimate of $121 for UTC, marginally above its current market price. We are in the process of incorporating the first quarter earnings and shall update our analysis shortly.
Restructuring Activities Dig Into UTC’s First Quarter Profits
UTC undertakes restructuring activities such as headcount reductions and plant consolidations from time to time in an attempt to lower its operating costs. However, as these activities have one-time costs associated with them, they reduce profits for the quarter they are executed in. Last year, the company incurred $481 million in these restructuring costs, but they helped expand its segment operating margins to nearly 16%, from under 15% in 2012. In 2014, UTC anticipates to incur restructuring costs of $375 million, out of which it incurred $125 million in the first quarter. At the same time, these activities helped expand the company’s first quarter segment operating margin by 90 basis points, on a year-over-year basis.
We figure higher operating margins driven by these restructuring activities will enable UTC to compete more aggressively, as higher margins enable competitive pricing. This has been evident at UTC’s Otis segment which makes elevators and escalators. Large scale restructuring at this segment enabled it to compete more aggressively with lower-priced local alternatives in China, contributing to its overall growth. So, in our opinion, over the long term, gains from these restructuring activities will more than offset their one-time costs.
Commercial Aviation & U.S. Housing Market Drive Sales Growth In Q1
Excluding the effect from restructuring activities, all five UTC segments posted strong growth in their profits. Results at the company’s aerospace segments – Pratt & Whitney, UTAS and Sikorsky – were driven by higher demand from the global commercial aviation sector. As major airplane manufacturers including Boeing and Airbus raised their production rates to make timely deliveries against their soaring orders, shipments of commercial engines from Prat & Whitney and airplane components from UTAS rose. At the same time, higher demand for commercial helicopters from the global offshore oil production sector drove growth in Sikorsky’s first quarter results.
Results at UTC’s building market related segments – Otis and Climate, Controls & Security – also posted healthy growth in the first quarter on higher demand from the U.S. housing market and recovering construction spending from Europe. Higher demand from the U.S. housing market increased residential heating, ventilation, and air-conditioning system sales at CCS by 21% year-over-year. The company during its earnings presentation said that this growth in residential HVAC sales indicates that the U.S. housing market will likely continue to grow for the foreseeable future, as residential HVAC sales are generally a good indicator of the health of the U.S. housing market. In 2007, UTC’s residential HVAC sales tanked foretelling the upcoming housing downturn. Thus, we figure UTC’s building market related CCS segment could see healthy growth in the coming quarters. CCS provides Carrier branded HVAC systems as well as Kidde/Chubb branded building fire and security solutions.
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