When’s the last time you flew in an airplane?
Got inside an elevator?
Found yourself in a building with air conditioning?
There is a select group of companies out there that produce most of the products that form the backbone of our economy.
And you’ll sometimes find that these companies aren’t everyday, household names.
There are a lot of businesses out there quietly producing products and/or providing services that people and other businesses all around the world require every single day.
And many of them exhibit characteristics and sport fundamentals that are high quality, making them great long-term wealth builders.
While you may not know who makes the engine running the airplane you’re on, the elevator you ride, or the air conditioning system cooling the air around you, that doesn’t make these products any less necessary, important, or lucrative.
Take a company like United Technologies Corporation (UTX), for instance.
This is a fantastic industrial conglomerate that produces some of the products mentioned above – and they’ve been producing products that the world needs since they were founded in 1934.
Oh, and they’ve been paying increasing dividends for over two decades.
A record like that doesn’t materialize if a company isn’t regularly increasing its profit.
And profit doesn’t increase if a company isn’t producing the products and/or providing the services that others require.
United Technologies provides products and services to the building and aerospace industries on a worldwide scale.
They operate in four segments: UTC Climate, Controls, & Security, 29% of fiscal year 2017 pre-consolidated sales; Pratt & Whitney, 26%; UTC Aerospace Systems, 24%; Otis, 20%.
So check this out…
Otis is the world’s largest manufacturer of elevators and escalators. Pratt & Whitney is a leading manufacturer of aircraft engines. And their Climate, Controls, & Security division is a leading supplier of HVAC solutions, including Carrier.
These may not be products that you think of as you go about your everyday life, but these products do indeed make the world work as we expect.
Imagine a skyscraper without an elevator to move throughout the building efficiently.
Imagine an office building without an HVAC system to keep it cool in the summer.
Imagine the F-35 Joint Strike Fighter without an engine.
United Technologies not only provides key industrial products and services, but it does so in such a way that they’re a leader in almost every area they operate. And they’ve been doing this pretty consistently going as far back as I can see.
Let’s take a look at their 10-year top-line and bottom-line growth.
I look at a company’s growth across the preceding decade to see how they’ve performed. Past performance is certainly no guarantee of future success, but ten years tends to smooth out a business cycle, which gives a prudent investor a good idea of how the business is doing over the long run. Their fiscal year ends December 31.
Revenue has increased from $59.757 billion in FY 2008 to $59.837 billion in FY 2017. Revenue growth has been essentially non-existent.
Not what we want to see; however, there were two major challenges over this period.
The financial crisis directly and significantly impacted United Technologies just like most other businesses. And the sale of the Sikorsky Aircraft business in 2015 for $9 billion jettisoned a fairly large segment of the company.
Earnings per share grew from $4.90 to $5.70 over this same decade, which is a CAGR of 1.69%.
Share buybacks have driven all of this excess bottom-line growth, with the outstanding share count down by approximately 16% over the last ten years. Much of that has occurred over the last two years, after United Technologies initiated a rather large buyback program with the proceeds from the Sikorsky sale.
Looking out over the next three years, CFRA is predicting that United Technologies will compound its EPS at an annual rate of 12%.
That would be a wonderful improvement. The last decade has been, frankly, disappointing.
To its credit, the company did report a strong Q4 for FY 2017, with its strongest organic sales growth in three years. And United Technologies expects accelerating sales, earnings and free cash flow growth in 2018.
But what about the dividend?
I have great news here.
United Technologies takes its relationship with shareholders seriously. So seriously, in fact, that they’ve paid an increasing dividend for 24 consecutive years.
As such, they’re featured as a “Contender” on David Fish’s Dividend Champions, Contenders, and Challengers list, which tracks over 800 US-listed stocks that have paid increasing dividends for at least the last five consecutive years
25 consecutive years of dividend increases will qualify them as a “Champion”, which they’re on the cusp of.
Meanwhile, they haven’t just paid a little more here and there.
These dividend raises have been meaningful.
Over the last decade, UTX has increased its dividend at an annual rate of 9.0%.
That’s pretty outstanding. It’s certainly well above the rate of inflation over that same stretch of time, which means shareholders have seen their purchasing power increase year after year.
And while they’ve been increasing their dividend for 24 consecutive years, they’ve actually paid a dividend since 1936 – we’re talking 82 years!
That stretches through multiple wars, global recessions, massive inflation, terrorist attacks, and countless natural disasters. The dividend just kept on coming.
And the current payout ratio is setting the future up for more dividends and more dividend increases.
At 49.1%, it’s very near what I consider a “perfect” balance between retaining profit for funding growth and paying shareholders their fair share of profit.
I consider a payout ratio of 50% to be that perfect, harmonious balance.
However, the payout ratio has been steadily rising over the last decade, because the company has simply been increasing the dividend faster than EPS would allow for.
As such, dividend growth will have to more or less mirror EPS growth moving forward, which means shareholders will have to count on the aforementioned growth acceleration to play out.
The yield, at just 2.1%, leaves a bit to be desired.
It’s below the stock’s own five-year average yield of 2.3%.
But if the company can deliver high-single-digit dividend growth, that makes for a pretty compelling total return picture over the long run.
The balance sheet is solid, although there’s been some slight deterioration here in recent years.
The long-term debt/equity ratio is 0.84, and the interest coverage ratio is over 9. Plus, the balance sheet sports almost $9 billion in cash.
Profitability is fairly robust, but I see room for improvement here.
Over the last five years, the company has averaged net margin of 9.74% per year and return on equity of 19.96% per year.
I’m a shareholder in United Technologies, owning shares in my real-life and real-money dividend growth stock portfolio that generates enough passive growing dividend income for me to live off of in my 30s.
While the last decade hasn’t been the company’s finest 10-year stretch, they’re still positioned incredibly well moving forward – in terms of both increasing profit and increasing their dividend to shareholders.
One great aspect of the company is their diversification – across both industry and geography.
The business segments were discussed earlier.
Meanwhile, international sales account for approximately 62% of total revenue. The company is broadly diversified geographically, and it has exposure across the commercial, industrial, military spaces.
And while some companies with military exposure are overwhelmingly beholden to the US government, United Technologies generates less than 20% of their sales from the US government.
This is wonderful because budget cuts can severely impact businesses that generate a substantial portion of their sales from US government contracts. United Technologies is somewhat insulated from this.
I love to invest in companies that provide products and/or services that are ubiquitous.
Well, it’s hard to ignore a company that is one of the world’s most prolific manufacturers of elevators, escalators, jet engines, and air conditioning systems.
The scale necessary to produce products like elevators, jet engines, and HVAC systems is pretty large, which creates a competitive advantage all by itself.
In addition, once you garner key long-term contracts with certain products, it’s likely that those contracts will continue if the supplying company continues to live up to expectations.
After all, you don’t just start switching out elevators or jet engines when the infrastructure is based around those products. And the company’s broad scope and diversification across industries, products, customers, and geographies means they’re somewhat insulated from significant business downturns.
To further bolster the depth and breadth of their offerings across vertical platforms, United Technologies agreed in late 2017 to acquire Rockwell Collins Inc. (COL) for $30 billion in cash and stock.
This acquisition is highly complementary, as Rockwell Collins is a leader in aviation and high-integrity solutions for commercial and military customers. Rockwell Collins is globally recognized for its leading-edge avionics, flight controls, aircraft interior and data connectivity solutions.
United Technologies sees significant cost synergies, and they expect the acquisition to be accretive to adjusted EPS within the first full year of closing.
While this is a great business with competitive advantages and a longstanding track record of success, there are risks to consider.
One has to keep in mind that the company’s earnings and revenue can be cyclic in nature. Demand for some of their products can vary based on life cycles.
In addition, there is also competition to worry about, specifically in some of the aerospace and security businesses.
They’re exposed to regulatory and litigation risks.
And they also face some exposure to US military budgets.
Shares are trading hands for a P/E ratio of 23.1, which is quite a bit higher than the stock’s five-year average P/E ratio of 18.7.
Most basic valuation metrics are higher than their respective recent historical averages, and some are higher than the broader market.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7.5% long-term growth rate.
That long-term DGR is below the company’s demonstrated dividend growth over the last decade. It’s also below the forward-looking forecast for EPS growth, which could and should allow for similar dividend growth.
That said, dividend growth has decelerated markedly in recent years. And any hiccups with their large acquisitions could affect near-term dividend growth, which would also affect the long-term average.
All in all, I think this is a reasonable look at the company’s long-term dividend growth potential.
The DDM analysis gives me a fair value of $120.40.
The stock thus looks moderately overvalued with a current stock price of around $130/share.
Bottom line: United Technologies Corporation (UTX) is an industrial conglomerate that is a leader in many of the segments it competes in. It’s a global leader across numerous business segments. It’s been paying a dividend for 82 years straight, and it’s been raising that dividend for the last 24 consecutive years. The results speak for themselves. Its wide diversification across industries, customers, products, and geographies means the company is positioned very well to continue delivering increasing profit and dividends for shareholders for many more years to come.
— Jason Fieber
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