Let me be clear, I don’t believe in trying to time the market, but I do believe in looking at stocks relative to their peers and assessing how attractive they are. Sometimes this means you’ll find an opportunity where the market is underestimating an opportunity. However, what I’ve found also are times where the best thing investors can do is wait to add to a position. This seems to be the case with United Technologies Corporation (NYSE:UTX).
Acquisition Indigestion
United Technologies is a remarkable company that sells everything from elevator parts to jet engines. I think the stock will do well over the long-term. However, today is one of those times to wait for a better buying opportunity.
Part of the problem is, United Technologies Corporation (NYSE:UTX)’s multiple acquisitions over the last few years. The most notable was Goodrich, which added significant debt to their balance sheet, and is also hampering their margins. The company knows its debt level is a little higher than they are comfortable with. CEO Louis Chenevert mentioned this specifically when he said, “we delivered on our commitment to pay down approximately one-third of the Goodrich acquisition debt.”
How Bad Is It?
Where United Tech.’s debt is concerned, I’m not suggesting the company is struggling to meet its debt commitments. However, this additional debt causes a headwind the company hasn’t been dealing with. Prior to the Goodrich acquisition, United Tech.’s debt-to-equity ratio was about 0.42, as of today, this ratio stands at 0.80. Relative to its peers, this puts United Technologies Corporation (NYSE:UTX) about the middle of the pack.
General Electric Company (NYSE:GE) is a direct competitor in the area of jet engines, climate control, and others. In GE’s recent quarter, their debt-to-equity ratio was 1.92. Of course, part of the reason GE’s debt-to-equity ratio is so high is because of GE Capital. In fact, without GE Capital, General Electric Company (NYSE:GE)’s debt-to-equity lead on United Tech. is substantially more, with a debt-to-equity ratio of just 0.09.
The Boeing Company (NYSE:BA) is the company United Tech. hoped to get closer to with the Goodrich acquisition. Between Goodrich and United Tech.’s existing Pratt & Whitney business, the company figures to play a central role in the thousands of jet orders that Boeing has in its backlog. Boeing’s debt-to-equity ratio stands at 1.53. Finally, Johnson Controls, Inc. (NYSE:JCI) is a competitor in the climate control business, and carries a debt-to-equity ratio of 0.46. As you can see United Tech.’s balance sheet is neither the strongest or weakest, last year United Technologies Corporation (NYSE:UTX) would have led this comparison.
United Tech.’s margins are also being compressed by the Goodrich acquisition. Specifically, the company’s operating margin was 11.4%, but in the UTC Climate, Pratt & Whitney, and Sikorsky businesses, operating margins were down year-over-year. Each of these divisions is affected by acquisition costs, and this puts pressure on management to realize cost savings.
United Tech.’s operating margin last year was in the mid-teens. Today, General Electric Company (NYSE:GE) has the best margin of the group at 17.02%. While GE Capital does contribute to GE’s better overall margin, the company’s Power & Water, Aviation, and Transportation units actually all carry higher margins and contribute more to GE’s total profits. The Boeing Company (NYSE:BA)’s aviation focus puts their operating margin at 7.3%, and Johnson Controls, Inc. (NYSE:JCI) diverse units puts that company’s margin at 4.38%. Last year, United Technologies Corporation (NYSE:UTX) would have led or been very close to the lead in operating margin, this year, they rank closer to the middle of the pack.
Valuation Matters
I’ve read several articles over the years that suggested valuation may not matter when buying “great companies.” I disagree completely, and so did one of the greatest investors of all time, Peter Lynch. As an example, investors thought Microsoft Corporation (NASDAQ:MSFT), Cisco Systems, Inc. (NASDAQ:CSCO), and EMC Corporation (NYSE:EMC) were “great” companies before the year 2000. The truth is, all of these companies were great, but their stock prices were far too high priced. Each of these companies is a poster child for Lynch’s comment that, if you pay too much for a blue-chip company you can still lose money.
One way to measure the relative value of dividend paying stocks is by using a ratio that Lynch used. He suggested the PEG+Y ratio as a way to compare companies. The PEG+Y is like an inverted PEG ratio, in the sense that it takes into account the yield, expected growth rate, and P/E ratio of each company. The stock with the highest combination of yield and growth, and the lowest relative P/E ratio will score the best. Unlike the PEG, with the PEG+Y, the higher the number the better. This ratio is yet another reason I believe it’s time for United Technologies Corporation (NYSE:UTX) to take a rest.
Using the PEG+Y ratio, United Tech.’s yield of 2.3% and growth rate of 13.65% gives a total expected return of 15.95%. If you take this total expected return, and divide by the forward P/E ratio of 15.32, you get a ratio of 1.04. Relatively speaking, United Tech. is a better value than Johnson Controls, with a ratio of 1.02. This shouldn’t be a surprise, since Johnson Controls has a lower yield, lower growth rate, and only slightly lower P/E ratio.
However, using these same calculations, General Electric Company (NYSE:GE) looks like a better value, as does Boeing. General Electric pays a higher yield at 3.29%, and though their growth is lower, so is their P/E ratio. Boeing has a similar yield, similar growth rate, but a lower P/E than United Tech. With PEG+Y ratios of 1.05 at GE, and 1.18 at Boeing, it’s hard to recommend putting more money into United Technologies Corporation (NYSE:UTX) at this time.
I’m not suggesting shorting the stock or anything crazy like that. However, when investors can buy equally impressive companies (GE or Boeing) at a better relative value, I would suggest investors add UTX to their Watchlist to look for a better entry point.
The article 3 Reasons It’s Time for a Rest for This Stock originally appeared on Fool.com and is written by Chad Henage.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
