Recent Buy

buyAs I’ve noted a few times recently, there are a number of really high-quality dividend growth stocks that have already corrected rather significantly on an individual level, even while the broader stock market remains near its all-time high.

But that’s one reason I love investing the way I do.

I don’t really need to worry about what the whole stock market is doing. I just need to find one stock at any given time that appears to be priced at a value relative to its intrinsic worth.

And I think I did just that with this recent buy.

This is a blue-chip stock across the board and one I’ve watched for some time now. The recent activity brought it down to a level where I thought it was priced below its fair value. So I pulled the trigger.

I purchased 15 shares of United Technologies Corporation (UTX) on 8/4/15 for $99.12 per share.

Overview

United Technologies Corporation is a diversified industrial conglomerate that manufactures and markets a diverse array of products primarily for the construction and aerospace industries.

Founded in 1934, they now sport a market cap just north of $87 billion.

Their primary branded products include Otis elevators, Pratt & Whitney aircraft engines, Sikorsky aircraft, and Carrier HVAC systems.

United Technologies operates in the following segments: UTC Climate, Controls & Security (25% of fiscal year 2014 revenue), Pratt & Whitney (22%), UTC Aerospace Systems (22%), Otis (20%), and Sikorsky (11%).

The company, however, in July announced the sale of Sikorsky to Lockheed Martin Corporation (LMT) for $9 billion, meaning this segment will disappear moving forward.

International sales accounted for approximately 63% of FY 2014 revenue.

Fundamentals

One reason UTX has long been on my radar is due to the fantastic fundamentals the company exhibits. Although a cyclical company by the very nature of the business model and the industries they serve, their growth is about as secular as it gets for a company with heavy exposure to cyclical areas of the economy.

We’ll first look at growth over the last decade, which allows us to smooth out those aforementioned cycles a bit.

From fiscal years 2005 to 2014, revenue grew from $42.725 billion to $65.100 billion. That’s a compound annual growth rate of 4.79%.

Meanwhile, earnings per share is up increased from $3.03 to $6.82 over this time frame, which is a CAGR of 9.43%. What’s really wonderful here is that during this stretch, EPS growth was fairly steady. It dipped during the financial crisis some, but not substantially. And the results came back pretty strongly thereafter.

That excess bottom-line growth was driven in large part by extensive share repurchasing activity, with United Technologies reducing its outstanding share count by approximately 10% over that 10-year stretch. In addition, improving margins helped.

S&P Capital IQ anticipates that the company will be able to grow its EPS at an 11% compound annual rate over the next three years, citing a strengthening US construction market and accelerating global air traffic growth. This prediction isn’t tremendously different than what UTX has done over the last decade.

Now, it’s one thing to grow at near double digits over a decade and operate at a high level. But that’s all for not, in my opinion, if a company isn’t sharing the growing profit pie with shareholders in the form of an incrementally increasing piece of pie. And it’s in that that United Technologies really impresses.

They’ve increased their dividend for the past 22 consecutive years, which is a solid track in and of itself. But I also think it’s highly likely this activity will continue well into the future (or else I wouldn’t be investing in the company).

A moderate payout ratio of just 36.7% seems to indicate this is a very plausible assumption. That means the company is paying a dividend that amounts to less than 37 cents of every dollar in profit they take in. That’s a fairly low number, leaving plenty of room for future dividend raises. In fact, dividend growth could outstrip EPS growth for the foreseeable future and the dividend would still remain sustainable as long as that growth difference remains reasonable.

We can actually see a growth difference over the last decade, as the dividend grew at an annual rate of 12.9% over that period. That spread could continue for a number of years before it would become problematic, but I suspect we’d see a smaller spread going forward.

The stock currently yields 2.58%. Although that’s well over the broader market, it’s also a bit lower than I usually look for. However, UTX rarely offers a very high yield – its five-year average is just 2.2% – and I believe the quality and growth potential offsets that.

Like many companies in the Industrials sector, United Technologies has a leveraged balance sheet. Their business model requires a rather heavy base of manufacturing assets, so this isn’t surprising. However, the leverage is anything but concerning.

They currently sport a long-term debt/equity ratio of 0.57 and an interest coverage ratio of approximately 9.

Profitability is also sound and compares well to the industry. Over the last five years, the company has averaged net margin of 8.86% and return on equity of 21.12%.

Qualitative Aspects

So an investment in this company is basically a play on two important, but different, industries: construction and aerospace.

Their primary branded products are dominant in aggregate, affording United Technologies leading positions in every market it serves across escalator and elevator systems, aircraft engines, technologically advanced aerospace products, and HVAC systems.

Most of the company’s primary businesses are very attractive due to limited competition. Pratt & Whitney, for instance, is one of only three major jet engine manufacturers, which leads to rational pricing and joint ventures.

In addition, high switching costs allow the company to profit handsomely from aftermarket and service once systems are installed. Otis is the world’s largest manufacturer and installer of elevators and escalators, and these aren’t systems that are easily removed once installed. Same goes for effectively all of their products.

Moreover, quality and reputation goes a long way with the products that the company manufactures and provides. Reliability and quality is taken pretty seriously when it comes to moving people up and down in tall buildings, or installing jet engines that have to operate at 100%.

The company also enjoys economies of scale by virtue of the sheer size and scope of their operations.

Urban population growth continues to increase year after year and is expected to remain that way, which means that construction (which will surely need HVAC systems) should remain strong for the foreseeable future. Notably, many of the world’s developing nations lie in areas where air conditioning will likely become more prevalent in the future. Furthermore, as cities grow, they’ll likely grow up rather than out. This means there will be a need for vertical transportation systems. These trends bode well for United Technologies.

In addition, airlines expect a sharp increase in rider demand over the next few years, which will increase not only the need for jet engines to keep up with supply, but also the wear and tear on existing pieces. We see this shaking out in the results. Pratt & Whitney’s backlog ended FY 2014 at $50.2 billion, up significantly from the $38.5 billion it finished 2013 at.

Risks

United Technologies is a global firm, with a majority of their sales generated abroad. As such, they face currency risks.

Competition, though limited in some of their primary businesses, is fierce in HVAC.

Even after the sale of Sikorsky, the company will still have some exposure to government orders and spending.

Although underlying growth over the last decade was fairly secular, the company is exposed to highly cyclical industries.

Valuation

UTX’s stock has fallen sharply YTD – it’s down more than 13% – with a sell-off occurring after the company announced the sale of Sikorsky and released Q2 results. I’ll quickly go over why I think the news about Sikorsky is actually rather fantastic and why there could be an opportunity at hand.

Sikorsky’s operating profit margin has fallen substantially over the last couple years, down from 10.5% in 2012 to 2.9% in 2014. The segment is contributing very little profit to the company at this point in time. And I think $9 billion is a very attractive price point for UTX here. Consider this: UTX’s total operating profit for the last fiscal year was approximately $10 billion. This is an $87-billion company. That’s less than nine times operating profit. Sikorsky’s operating profit for FY 2014 was just $219 million. Yet United Technologies is getting $9 billion for it – 41 times operating profit. There’s something to be said for Lockheed likely being able to squeeze more juice out of that lemon, but I think United Technologies did well here. Moreover, this reduces United Technologies’s exposure to government defense spending, which has shrunk as of late. All in all, I applaud this move.

United Technologies will largely be buying back stock with the proceeds, announcing an $8.3 billion share buyback program in conjunction with the Sikorsky sale. If I like the idea of buying this stock at $99, then I certainly like the idea of the company buying stock at $99. Although it shrinks the company’s revenue base in absolute terms, there will be less shares in existence when the buyback program ends, meaning every dollar of profit goes that much further. I think this will more than offset the earnings loss from Sikorsky due to the valuation, as I pointed out above. As such, this should be accretive over the next few years.

The stock trades hands for a P/E ratio of 14.22. This compares very favorably not only to the broader market, but also the five-year average P/E ratio of 16.4 for UTX. Not only is the stock cheaper than usual right now, but I think the quality is actually higher due to the moves they’re making.

I valued shares using a dividend discount model analysis with a 10% discount rate and a 7.5% long-term dividend growth rate. I think that growth rate is fair considering the low payout ratio and recent historical growth in underlying profit and the dividend. There appears to be a margin of safety in that model. The DDM analysis gives me a fair value of $110.08.

Conclusion

United Technologies is a high-quality company across the board. And there are a number of tailwinds at their back, leading me to believe that growth could be rather outstanding over the next decade or so. The company’s competitive advantages are immense and renewed focus on their higher-margin businesses could unleash even more potential than they’ve shown heretofore.

I view the current valuation as rather attractive. There appears to be a sizable margin of safety present even with a conservative analysis, which isn’t something you run into very often with a high-quality company that is otherwise operating at a high level. It’s not like United Technologies is on the operating table here and struggling. Recent guidance was slightly reduced, but they remain extremely well positioned across their other lines.

This purchase adds $38.40 to my annual dividend income, based on the current $0.64 quarterly dividend.

I’m going to include current valuation opinions from other analysts below, which I use to concentrate my reasonable valuation estimate:

Morningstar rates UTX as a 4/5 star valuation, with a fair value estimate of $120.00.

S&P Capital IQ rates UTX as a 4/5 star “buy”, with a fair value calculation of $109.10.

I’ll update my Freedom Fund in early September to reflect this recent purchase.

Full Disclosure: Long UTX.

What do you think of this stock here? Own UTX? Why or why not? 

Thanks for reading.

Photo Credit: Stuart Miles/FreeDigitalPhotos.net

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50 Comments

  1. Love the company, just wish I would have waited a bit longer to make a purchase like you have. I’m down double digit % on it but its a long term hold. If I had the capital, it would definitely be worth a look to make another purchase.

    You are killing it with adding capital this year! Congrats.

    ADD

  2. I noticed UTX recently on the news of the Sikorsky sale. I think it is a very good deal. As you note, its margins has sharply dropped recently and it will take quite a bit to get that back up again. As a result, it was hardly moving the needle for UTX so to be able to pull in $9 billion is not bad at all.

    I think this is a great purchase, Jason. The company is in some attractive long-term sectors even if–as you note–they are undoubtedly cyclical. Should serve you very well indeed. Here’s to another 22 years of dividend growth!

  3. I bought my stake in UTX a year ago and am fully invested for now, but I think you made a solid addition there!

  4. I just got some fresh powder (it’s rare here in my parts) and was just looking into UTX. Thanks for sharing your analysis. Maybe with all that cash they have some acquisitions up their sleeve. That could catalyze some of the growth you mentioned.

  5. ADD,

    I’m staying pretty busy this summer. Really grateful for that. Not sure how long it’ll go like that, so I’m taking advantage while I can. 🙂

    UTX is a really fine company. I’ve always thought it was interesting in that they have these really different segments operating under one roof. But Sikorsky fit even less than the rest, being a rotary business and all. And this reduces their exposure to the US government. I think they got a very, very attractive price for the business. We’ll see how it goes!

    Thanks for dropping by.

    Best regards.

  6. TDD,

    The market didn’t like the Sikorsky sale, but I do. Maybe LMT will be able to do more with it, but it was obviously languishing under UTX’s watch. They got a great price for it.

    Appreciate the support. Let’s stay busy!

    Best wishes.

  7. Chris,

    Glad to be a fellow shareholder with you here. I’ve long watched UTX from the sidelines, but this struck me as a great opportunity.

    Thanks for stopping in!

    Cheers.

  8. MMM,

    Nothing like some dry powder to deploy. Shopping is half the fun. 🙂

    Doesn’t look like any acquisitions are on the horizon. As I noted, UTX is apparently using the proceeds to buy back stock so as to offset the loss in EPS. But I think it’ll be accretive when it’s all said and done due to the valuation.

    Cheers!

  9. Great company, I’m buying at these levels as well, I hope they will use some of the $9 billion to pay off part of their massive debt.

  10. John,

    Definitely a high-quality company across the board. They’re in a great position to benefit from the building out/up of cities. 🙂

    As far as the $9 billion goes, they’ve noted that they’re going to offset the EPS loss from Sikorsky by buying back stock. You can read that in the article and/or the press release I linked to.

    Thanks for dropping by!

    Take care.

  11. Looking at the recent quarterly conference call, I actually think it is likely UTX is looking at acquisitions in the near to intermediate term.

    CEO Gregory Hayes alluded to it in his opening remarks “We also intend to explore additional benefits from capital deployment, both M&A and share buybacks” and further touched on this idea as part of his answer to the first question, saying “I think we’re done with the big divestitures. We’ve done $15 billion now, including Sikorsky in the last five years, so we like the portfolio that we have as a base off which to grow. And so the question is with capital deployment, where are we going to grow? Are we going to do more share buyback? Are we going to go to M&A? Obviously the preference is M&A. You alluded to the credit metrics, Jeff. I think obviously, the spin versus the sale to Lockheed Martin, that doesn’t really change the credit metrics that much. And I still think we have flexibility on the balance sheet to do things. And so the team is focused right now on M&A.”

    http://seekingalpha.com/article/3343755-united-technologies-utx-gregory-j-hayes-on-q2-2015-results-earnings-call-transcript?part=single

  12. RD,

    They may indeed decide to pursue acquisitions, and I’m sure management will target bolt-ons that make sense to the firm.

    But the actual proceeds from the LMT sale have apparently been earmarked toward buybacks, as I noted:

    “Proceeds from the sale are expected to be used to fund additional share repurchase to offset the earnings impact related to the sale.”

    “In addition, UTC’s Board of Directors has authorized a share repurchase program for up to 75 million shares of the company’s common stock, which would be worth approximately $8.3 billion based on the NYSE closing price of UTC shares on July 17.”

    http://www.utc.com/News/News-Center/Pages/United-Technologies-Announces-Agreement-To-Sell-Sikorsky-Aircraft.aspx

    That capital may be spread out a bit more than anticipated, but it looks like they’re going to offset the earnings impact as described. Can acquisitions and buybacks happen concurrently? Absolutely. But the proceeds from Sikorsky are apparently moving in the direction described.

    Cheers!

  13. Our brainwaves must be in alignment I bought UTX last week. An excellent company with very good valuation. It’s an initial position so I have wiggle room to add more if the market goes south.
    Congrats on the purchase!
    D4s

  14. D4s,

    I guess great minds think alike. 🙂

    I’m with you on averaging down. I wouldn’t mind another tranche if it drops significantly from here. I also wouldn’t mind buying more at this price, but I’ll have to see what other opportunities are out there. I have to be careful in regards to how many stocks I buy with that lowish yield.

    Thanks for the support!

    Best regards.

  15. DM,

    Great write-up for an excellent company! UTX popped on my radar after the most recent earnings report, although I have followed the stock for the past 2 – 3 years (long before I decided to accumulate DG stocks). I’ve been teetering between purchasing EMR, UTX, or PH but finally decided to go with EMR last week.

    I hope to join you in the UTX shareholders club sometime soon, if the company remains at these price levels or dips further i’ll be hard pressed not to pull the trigger.

    Regards,
    Dividend Odyssey

  16. DO,

    I, too, have been following the stock for some time now. Glad to finally own a small slice of the company. 🙂

    Nice buy there on Emerson. Some of the high-quality Industrials have been really smacked around recently. And that’s why I’ve been busy there.

    Keep it up!

    Take care.

  17. Jason,

    Congrats on the purchase and that was a great write up! I agree with your thesis and UTX was actually the first stock in my own dividend growth portfolio. A couple of points I just wanted to add…

    UTX has a habit of raising the dividend every 5 quarters rather than yearly. It’s still growing, but we do have to wait an extra quarter for a raise.
    The old CEO (Louis Chenevert) left in December (supposidly the board forced him out) and since that time there have been several upper management changes, it’ll be interesting to see how else the company changes besides the Sikorsky sale.

  18. Peter,

    Glad to be a fellow shareholder! 🙂

    Good point on the frequency of dividend increases. Doesn’t really bother me, though, as long as the increases come as designed.

    As far as the management changes go, I actually think this is a positive. Chenevert appeared to be pretty firm on Sikorsky being there to stay. But we can clearly see that operations there have been languishing. So it was time to either go all-in or get rid of it. I think the latter makes sense in this environment.

    Thanks for adding that. Excited to see where it goes!

    Best wishes.

  19. DR,

    Ha! I wish I could buy whenever I want, but sadly that’s not the case. However, I’ve been fortunate to stay fairly busy lately.

    Hope you’re having a great August over there!

    Take care.

  20. Sweet buy on UTX Jason, I own this one in my portfolio. I high quality stock with a buy back and a great dividend. I have pretty much a full position, but will be glad to add more of this high quality stock on any more pull back. Congrats on this buy Jason.

    Cheers

  21. michael,

    Glad to be on board with you here. I’m pretty confident UTX will keep rewarding us for many, many years to come. 🙂

    Thanks for stopping by. Hope you enjoyed the analysis!

    Cheers.

  22. CG,

    Thanks so much. I’m rolling away with as much effort as I can muster. 🙂

    Hope the gains are coming in fast for you over there.

    Cheers!

  23. WB likes industrial so do I. I would be buying UTX this month. I only have 5% of my portfolio in cash so want to wait couple weeks, but love to own UTX by end of the month.

  24. what’s your opinion on XOM? I was thinking buying 100 shares if falls to 75. Do think it will fall that low?

  25. Nice – I’ve been watching this one since you mentioned it like a month + 1/2 ago. Curious about your article that you wrote about what you would buy if you were just starting out and I think it was like JNJ/ PM/ KMI. What is your take on KMI right now.

  26. Hi Jason,

    We cannot stop buying, amazing last 2 months on that side. This company seems amazing and will have a nice contribution to your snow ball.

    Cheers,

    RA50

  27. AJ,

    UTX definitely appears to be a pretty compelling opportunity here. Of course, there are a few opportunities right now in the Industrials sector. It’s good to be an investor with some cash. 🙂

    Cheers!

  28. Dwayne,

    I have no idea where XOM’s stock is going to go. I can only say that I picked up shares at $84 when oil was around $100/barrel. Oil is now less than half that and XOM’s stock is sitting at $77. So you can see the spread there. Lower earnings haven’t worked their way through yet, but I have no idea how that’ll impact the stock.

    Take care!

  29. dzogen,

    My opinion on Kinder Morgan the company hasn’t changed. My opinion on the stock has only become more favorable as it’s become cheaper. The cheaper it gets, the more I like it. I already have more than enough, but I’d be a buyer right now if the situation were different.

    Cheers.

  30. Awesome purchase, awesome company mate. You’ll achieve a five digit income + in no time. I’m back in the game now with dividend investing as well! No more excuses!

  31. aussiestocks,

    Thanks so much. It’s coming along pretty nicely. I’m very, very fortunate in many ways. 🙂

    Glad to hear you’re back at it. The journey is so incredibly rewarding. And you become freer with every single dollar saved/invested.

    Cheers!

  32. Jason – quick question on how you are going to handle BXLT if Shire comes in with a smoking hot offer. Sell and reallocate or go with Shire? I’m torn with what to do. Personally, I think they are low balling BXLT!

  33. Brent,

    That’s a good question. I’d probably just consider things as I go. If it’s an all-stock offer, I’d likely move on. Shire’s yield is below even my liberal limit on low-yield stocks. I’m usually not happy about buyouts and what not, but I wouldn’t totally miss BXLT if it were bought out for a premium due to the unfavorable change in the dividend after the spin-off.

    Cheers!

  34. Good buy, DM! I like the fundamentals of UTX along with other industrials: CAT and EMR. I’ve bought the last one and other 2 are in my watch list. Keep racing towards FI with each buy.

  35. DD,

    I’m rolling away with extreme excitement and effort. 🙂

    Looks like you’re rolling away over there as well with excellent progress. Keep it up!

    Best regards.

  36. R2R,

    There’s definitely some solid opportunities in the Industrials, which is just wonderful. The market might be expensive, but not all individual stocks are. 🙂

    You’ve been staying busy over there. Wish I could buy with as much frequency as you’ve been, but I lack that kind of wherewithal. Keep it moving!

    Take care.

  37. Hi Jason,

    Great article, I think you made a nice purchase. UTX has been one of the most consistent dividend stocks I have come across over the past decade. Never a bad thing to see a conglomerate re-focus on its core strengths through a divestiture, either.

    Best,
    Simply Safe Dividends

  38. SSS,

    Thanks. Glad you enjoyed the article!

    I agree. The focus should better serve shareholders. And the $9 billion they got for a struggling unit seems to unlock a lot of value right off the bat. Excited to see where it goes.

    Thanks for dropping by.

    Cheers!

  39. I’ve had UTX on my watch list for the longest time and just never pulled the trigger. Perhaps it was because I felt sufficiently diversified among the industrial names and for a long time it seemed a bit expensive with a less than attractive yield. I guess now around $100 after dropping from around the $120s makes this one a little more attractive in many respects. Still, this is a solid well diversified name that will make you a happy camper for years to come. Thanks for sharing.

  40. Keith,

    Yeah, I’m with you there. UTX has long been on my watch list as well, but always fell into that “not right now” pile. It just recently became pretty compelling for me. I think the Sikorsky move makes a lot of sense here.

    Thanks for dropping by. Hope all is well!

    Best wishes.

  41. I was looking at all sorts of industrials for this month, then went boring and picked up 20 more shares of WMT instead. Ho hum, another 39.20 in annual dividends.

  42. Hi Jason,

    You convinced me to put them on my watch list. I just took my latest dividends and got 18 shares of TGT today. Thanks for the solid info and opening my eyes on this one.

    John

  43. John,

    Absolutely! I’m more than happy to share my ideas as they come in. 🙂

    Thanks for dropping by. Have a great weekend over there.

    Best regards.

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