United Technologies Crushes Expectations

United Technologies UTX crushed fourth-quarter 2018 consensus EPS of $1.53 by around 40 cents thanks to taxes and strong performance from recently acquired Rockwell Collins (dilution was 3 cents compared with management expectations of 10 cents). We count the solid outlook for Rockwell’s 2019 cash flow coupled with acquisition synergies already coming through as positives as well. The name rallied 5% post-earnings but our $144 fair value still implies 20% upside. We also updated our sum of the parts valuation, which resulted in a $173 value in a breakup scenario compared with $168 previously.

Strong growth out of the aerospace businesses confirms the logic behind management's plans to spin off the other businesses. Pratt & Whitney registered 22% organic growth due primarily to the GTF; engine shipments were up sequentially and full-year 2018 came in at roughly twice 2017 levels. After controlling for the incorporation of Rockwell late last year, legacy UTAS registered 8% aftermarket growth, and double-digit growth in parts and repairs. While organic growth out of Otis and CCS (now Carrier) during the quarter was respectable at 5% and 6%, respectively, these businesses continue to grow more slowly than aerospace.

Adjusted operating margins compressed year over year across all segments except for Otis. Nonetheless, Otis’ 2018 full-year performance was toward the bottom end of guidance. Pratt’s margins saw the most pressure, contracting nearly 300 basis points in the last quarter of 2018 due to negative margins on GTF. Despite hitting its growth targets and management highlighting strong pricing during the past quarter, Carrier missed on full-year profit growth. Lastly, Collins Aerospace posted performance in line with guidance.

Management issued 2019 guidance calling for an adjusted EPS midpoint of $7.80. The company anticipates 3%-5% organic growth and 2019 free cash flow of at least $6 billion excluding $1.5 billion separation costs related to the breakup.

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