Three industrial companies have made their debut at possibly the worst time for any business.
Yet the three— Raytheon Technologies (RTX), Otis Worldwide (OTIS), and Carrier Global (CARR)—all look appealing, despite a downturn that will sap this year’s results. Their emergence follows the completion earlier this month of the merger between Raytheon and United Technologies.
Raytheon Technologies is by far the largest of the three, with a market value of $95 billion. It consists of United Technologies’ commercial aircraft operations, including the Pratt & Whitney engine business; a defense unit, and all of Raytheon, one of the leading defense contractors. Its shares, at a recent $65, trade for 17 times projected 2020 earnings of $3.82 a share.
The bull case for Raytheon Technologies is that its relatively stable defense business—accounting for about 65% of projected revenues in 2020 and 2021—should anchor the company until a rebound in the hard-hit aerospace units comes in 2022.
The company “ran into the buzz saw of the biggest downturn in aerospace history,” says Carter Copeland, an analyst with Melius Research. “You have to believe that people will hop on planes again and that the industry will need new jet engines and that planes will consume spare parts.”
Calling Raytheon Technologies a “lower risk” way to invest in aerospace, compared with Boeing (BA) and Airbus (EADSY), he has a Buy rating and a $80 price target on the stock.
During 2019, United Technologies and Raytheon projected $8 billion to $9 billion in free cash flow in 2021 for the new Raytheon Technologies. But $6 billion now looks more likely, with $7 billion to $8 billion—about $5 a share—possible in 2022. That is against $7.5 billion last year and a projected $4.5 billion for 2020.
“Not exactly the way we had expected to start this great company, but we’ll get through it,” Greg Hayes, Raytheon Technologies CEO (and former boss of United Technologies), told Fox Business in early April. The company, he said, would rely on its defense businesses, with their $70 billion contract backlog, for growth in the near term.
One risk for Pratt & Whitney is that accelerated retirement of older jets from airline fleets will hurt its lucrative spare parts business. But it should benefit in the coming years from an upturn in profits on its new jet engine (called the geared turbofan) for narrow-body Airbus planes.
In the merger, Raytheon holders received 2.335 shares of Raytheon Technologies for each of their shares, while United Technologies holders received one share of Raytheon Technologies, one of Carrier, and a half-share of Otis for each United Technologies share.
Otis recently traded at $45, and has the highest valuation among the three, at 23 times projected 2020 earnings of $1.94 a share. This reflects Otis’ position as one of the five global leaders in elevators and the only elevator pure play in the U.S. stock market.
JPMorgan analyst Stephen Tusa began coverage of Otis with an Overweight rating and a $53 price target.
“It’s a strong franchise in an attractive industry and better earnings visibility in the downturn,” relative to others in the building-services industry, Tusa says. Elevators, he noted in a recent report, “are like the aircraft engine of the building, a technical, mission-critical piece of equipment for which failure is not an option.”
Otis notes that about a third of the 16 million elevators around the world are at least 20 years old. About 80% of its earnings come from stable services revenue. The company’s medium-term goal is high single-digit annual growth in earnings per share. Earnings may decline 14% this year, to $1.94 a share, before rebounding to $2.20 in 2021.
With a high tax rate of 33% depressing earnings, Tusa prefers to value Otis based on enterprise value (equity market value, plus net debt) divided by earnings before interest, taxes, depreciation, and amortization, or Ebitda, which is more reasonable at around 12.5, based on this year’s projected results, and represents a discount to rivals Kone (KNYJY) and Schindler Holding (SHLRF).
Carrier is a top maker of air-conditioning and heating systems. It is the deep-value stock of the three, trading at $13, or about 10 times this year’s projected earnings per share. A big knock against Carrier is its heavy net debt of $10 billion, or five times estimated 2020 pretax cash flow (Ebitda). Most companies like to keep the ratio of debt to Ebitda to three times or less.
Wolfe Research analyst Nigel Coe began coverage of Carrier with an Outperform rating and a $26 stock price target. He sees “substantial opportunities to improve margins and pay down debt,” according to a note.
Coe projects $1.2 billion of free cash flow this year, rising to $2 billion by 2022 or 2023. Revenue this year is expected to be down 15%, to $16 billion, with reported earnings off by a third. Carrier, he wrote, is “best viewed as a deleveraging and restructuring story—perhaps not the jazziest equity story, but one that we think can deliver significant upside, if executed well.”
Carrier may set a dividend that could be 4%, according to Barclays analyst Julian Mitchell. Raytheon and Otis are each expected to yield about 2%.
In sum, Raytheon Technologies is a mix of a stable defense unit and a recovering aerospace division. Otis offers a pure play on an attractive global oligopoly, while Carrier is an industry leader with a depressed price.
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