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United Tech's Geared Turbofan May Finally Be Wind Beneath Earnings Wings

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The Geared Turbofan jet engine from United Technologies' ( UTX ) Pratt & Whitney unit may transform from a drag on earnings to a significant profit driver over the next decade, according to one analyst.

[ibd-display-video id=3037819 width=50 float=left autostart=true] United Tech invested roughly $15 billion in its next-gen Geared Turbofan (GTF), which allows different engine components to operate at different speeds, improving fuel efficiency while producing less noise and exhaust. Hopes were high as Pratt & Whitney sought to dethrone General Electric's ( GE ) Leap engine.

But manufacturing issues and delays dogged the GTF, testing the patience of shareholders as well as customers like Qatar Airways and Airbus ( EADSY ). Delta Air Lines ( DAL ) also has ordered the engines for its 100 A321neo aircraft , set for delivery in early 2020. In October, United Tech backed its target of 350-400 GTF deliveries for 2017 as it resolves production problems.

In a note to clients Wednesday, RBC Capital Markets analyst Matthew McConnell wrote that initial "engine teething issues" seem to have been fixed, paving the path for a successful ramp-up in GTF production and deliveries.

"We believe the long-term growth opportunity at Pratt & Whitney is underappreciated, not just as the GTF ramps up and engine kinks are fully derisked, but also given the rich aftermarket opportunity from its large installed base of V2500s, competitive take-aways on key upcoming business jet platforms, and Pratt's sole-source position on all three Air Force mega programs," McConnell said.

The Connecticut-based United Tech, a Dow Jones industrial average components, competes with fellow Dow stock GE and Rolls-Royce in the aerospace and defense markets, supplying engines to massive Pentagon programs like Lockheed Martin's ( LMT ) F-35.

McConnell expects 2018 to mark the final year of margin headwinds in Pratt that have weighed on United Tech shares. The business could generate double-digit operating profit growth over the next 10 years, driving free cash flow of $10 per share by 2020, he estimated.

However, he cautioned it is "too early to declare victory" on the GTF ramp-up, from 138 in 2016 to 700-plus in 2018. United Tech fell short of its target for 200 GTF deliveries in 2016, he added, and more challenges could result in "further penalties and potentially order cancellations," weighing on investor sentiment.

Shares of United Tech were up 0.4% at 130.59 on the stock market today , after rallying 1.5% Wednesday on the RBC note, which also upgraded the stock to outperform. The stock is out of proper buy range after breaking out from a 123.38 cup-with-handle entry. GE rose 2%, Airbus jumped 2.6%, while Delta was flat.

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In his Wednesday note, McConnell also described United Tech's Rockwell Collins (COL) acquisition as a key free cash flow driver.

"Rockwell Collins has among the stronger underlying outlooks of its commercial aerospace peers, driven by significant new content wins on next-generation platforms that position it well for the next five years," he said, while noting that the "pricey" $30 billion buy will likely deliver a return on investment in roughly five years.

But the deal reportedly raised concerns from Airbus that it would keep United Tech from fixing the problems that delayed aircraft deliveries.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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