2018 Bull/Bear Outlook: How M&A May Make United Tech Look Even Better

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Now that 2017 is gone, investors have to figure out how they want to be positioned for 2018 and beyond. The Dow Jones Industrial Average (DJIA) and S&P 500 have risen exponentially since the March 2009 panic-selling lows. Investors have to consider that the bull market is nearing nine years old and that it has been a stronger bull market than most people have ever seen.

The Dow rose 25% and the S&P 500 rose by almost 19.5% in 2017. Those gains greatly outpaced expectations that were forecast at the start of 2017. And most Wall Street strategists are calling for the stock market to rise yet again in 2018 on the heels of tax reform, broader earnings growth and higher gross domestic product growth.

24/7 Wall St. just came out with its annualized forecasting tool showing that DJIA at 26,400 and at least 2,855 on the S&P 500 are the baseline targets for 2018. For these gains to continue, United Technologies Corp. (NYSE: UTX) is going to have play at least a small part.

It turns out that UTC generated a return of 16.4% in 2017, far better than the return of 7.5% that was projected a year ago. That being said, the stock lagged the Dow handily and slightly lagged the gains of the S&P 500 Index.

The conglomerate closed out 2017 at $127.57, and the consensus target price of $128.07 and dividend yield of 2.19% would imply an expected total return of just 2.58% in 2017. This feels low for a company that wants to make acquisitions and that also is willing to pare off some assets if needed. It seems very possible that Wall Street in general is greatly underestimating this well-run conglomerate.

RBC Capital Markets kicked off 2018 with a big analyst upgrade for UTC. The firm raised the shares to Outperform from Sector Perform and catapulted its price target to $160 from $124. Thomson Reuters showed that its prior street-high analyst target was only about $128. This higher target price raised the consensus target to almost $131. The call is so aggressive that it should offer more than enough cushion for analysts to raise their price targets modestly to aggressively without feeling all alone.

Back in October UTC raised its 2017 outlook, but there was some confusion over that raised guidance to a range of $6.58 to $6.63 in adjusted earnings per share. The company’s own communication was that its third quarter was its best quarter of organic growth since 2011.

Rockwell Collins Inc. (NYSE: COL) will convene a special meeting of its share owners on January 11, 2018, to vote on the proposals for acquisition of the company by UTC. Investors need to understand that this would-be deal has not yet been officially factored into potential earnings. Analysts on Wall Street generally are slow to factor in the impact on earnings, revenues and margins when two big companies combine.

UTC is not valued at any more premium to the market, roughly 19.3 times expected 2017 earnings and about 18.5 times expected 2018 earnings. Again, that does not include any benefit from the Rockwell Collins acquisition nor any other bolt-on acquisitions that may be coming its way.

At the end of 2017, the forward 2018 valuation for the S&P 500 Index was 18.5 times to 19.0 times expected earnings per share, per Yardeni Research and S&P research respectively.

After closing out 2017 at $127.57, UTC shares ended at about $130 on the second trading day of the year. That’s now above the prior year-end consensus target price of $128.07. It only seems natural that analysts are likely to follow RBC with higher price targets, even if the magnitude of that hike may be muted in comparison.

As far as how investors should be positioned for 2018, there are at least some risks and hurdles that should be given some thought. We have offered up 10 serious risks to the bull market in 2018. Investors might want to also consider lower volatility strategies in case a big correction looks more likely.