The Strategist

Is Sikorsky a drag on United Technologies?

03/17/2015 - 05:31

With a shrinking defense market is Sikorsky a drag on United Technologies? Or is it more in the nature of a long term investment?

Way back in December 2013, in an interview with Louis Chênevert, fomer chairman of United Technologies, the question of divesting Sikorsky from the company had come up. Sikorsky is a well-known division of United Technologies that manufactures helicopters.  The Marine One, the personal chopper of the US president, and the Black Hawk are the public face of Sikorsky.

The former chairman, made it pretty clear that Sikorsky was not on the chopping blocks. He said “We’ve got all these new product lines that we have won in the market that are in their infancy.”

In November this year, Mr. Chênevert was ousted since the board thought that his focus was not exclusively on the job. Several reports from insiders have mentioned the fact that this extreme step was taken either because his focus was more on building a yacht in Taiwan or maybe because he was getting way too attached with Sikorsky.

Gregory Hayes who succeeded Mr. Chênevert’s has announced that Unitech technologies is now looking for “strategic alternatives ”  which amongst other things includes the spinning of the Sikorsky division. In view of the now shrinking defense market, the move makes sense. Although Sikorsky gives United Technologies a high profile, it currently comes attached with low margins.

In an investor’s conference in New York, United Technologies presented charts which show that although other division were doing well, Sikorsky’s performance was way below standards. Its subpar performance in terms of revenue generation and in market growth led to this decision.

Although Sikorsky’s revenue rose by 10% its operating profit shrank from 10.5% to 2.9%. However, other divisions such as Goodrich, an aerospace division which is in the business of making jet engines, showed sales growth of more than 30%. Its operating margins climbed from a modest 11% to almost 17%.

With the expanding aerospace and aviation market, and with United Technologies getting better at what it does, revenues and operating margins are expected to go northwards. In this line of business, it’s all about operational leverage, i.e. generating additional operational earnings through relatively fixed investments in plant and machinery.

Mr. Hayes, went on to say that
“…[Sikorsky is] a very, very good business … [however] it’s just not quite the business we want … [because] but we won’t see any volume until the late 2020s”.

Although Sikorsky has order coming up to the tune of $438 million, with the Canadian Government placing orders for the Cyclone helicopters, however it acts as a drag on United Technologies since its price/earnings fall way below when compared to pure defense contractors such as BAE Systems and Lockheed Martin. At best, it has long term potential.

By carving off Sikorsky and by focusing purely on its growing stream of profits generated out of operations in commercial aerospace, United Technologies will have a free hand in drawing investor’s attention for its operations.

Mr. Hayes is targeting 0.3%-0.5% in operational profit growth per year, for the next decade. United Technology is expected to generate to generate $40-$50 billion in cash in the next decade, depending on whether it goes in for additional funding.