It’s been a roller coaster ride for United Technologies (NYSE:UTX) stock in the last six to nine months. From a high of $142 on Sept. 21, 2018, the stock slumped by 28.0% to $102 by Dec. 24, 2018.
The stock again surged by 39% and was back to $142 on April 30, 2019. With the news of merger with Raytheon (NYSE:RTN), the stock is marginally lower and currently trades at $128.90.
I am of the opinion that this downside is a good buying opportunity and investors with a long-term investment horizon can consider exposure to UTX stock.
Benefit From Merger Synergies
While the initial market reaction to the merger announcement was negative and uncertain, the stock price stabilizing and consolidating is an indication that the market participants see long-term value creation from the merger.
As a first positive, the merger will create the third-largest entity in the aerospace and defense space. Raytheon Technologies (name of merged entity) will be only behind Boeing (NYSE:BA) and Airbus (OTCMKTS:EADSY) considering 2018 sales. Importantly, the combined entity will be well diversified with 54% revenue from the defense sector and 46% from the commercial airspace sector.
Even in terms of regional diversification, Raytheon Technologies has 55% market share in the United States and 45% market share in international markets. With rising geopolitical tensions, the combined entity will be well positioned to expand on the defense sector market share globally.
It is also worth noting that both companies have complementary technology offerings and this will help in providing superior products and solutions. The key point to note here is that Raytheon Technologies is likely to invest $8 billion in research & development in 2019.
The R&D is likely to focus on hypersonic and future missile systems and artificial intelligence for commercial aviation, among others.
Raytheon Technologies is aiming to create cost-effective solutions for the defense sector, which is critical as defense budget escalate globally. Higher R&D is likely to translate into higher turnover and cash flows.
Value Unlocking and Shareholder Value Creation
Another positive that has currently been overshadowed by the merger news is the fact that the business combination excludes Otis and Carrier. These entities will be separated from United Technologies in the first half of 2020 and that leaves room for further value unlocking for shareholders.
It might still be too early to talk about shareholder value creation in the form of dividend and repurchases post the merger. However, the combined entity intends to return $18 to $20 billion to shareholders in the next 36 months.
I believe that the target can potentially be achieved considering the fact that the pro-forma 2019 free for Raytheon Technologies is likely to be $6 billion and the company intends to boost free cash flows to $8 billion by 2021.
In addition to higher dividends and share repurchase, I also believe that Raytheon Technologies will deleverage with the combined entity currently having a net debt of $26 billion. While the leverage stands at 1.92, debt reduction is likely considering the fact that Raytheon Technologies will be in a phase of capital expenditure investment cycle moderation.
Conclusion
For the first quarter of 2019, Raytheon reported revenue growth of 7.4% with an order backlog of $41.1 billion. For the same period, organic sales growth for United Technologies was 8.0%.
It seems very likely that the combined entity will continue to clock turnover growth in the range of 5% to 10%. If earnings per share growth sustains above 10%, Raytheon Technologies will see renewed interest from market participants.
I therefore believe that the sideways movement in the near term is a good accumulation opportunity and R&D driven growth is likely to ensure that the stock momentum sustains in the long term.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
