UTC’s Sikorsky Helicopter Business Is Poised For Long Term Growth Despite Weak U.S. Military Spending

United Technologies‘s (NYSE:UTX) helicopter production and service segment, Sikorsky, faced a very challenging 2013 due to spending cuts (called sequestration) launched by the U.S. government. As Sikorsky generates more than half of its revenue from the U.S. government, these cuts reduced its top line by nearly 8% annually to $6.3 billion last year. ^[1] However, looking ahead, Sikorsky anticipates its results to improve steadily driven by rising demand from international military helicopter markets and commercial helicopter markets, especially offshore oil rigs. The company currently anticipates its top line to rise in mid-single digits through the end of this decade driven by these growth trends, after falling by nearly 15% over the past couple of years. ^{[2] [1]}

We figure that in the coming years Sikorsky’s growth from commercial helicopter and international military markets will be moderated by weak defense spending in the U.S. In 2013, Sikorsky generated approximately 10% of United Technologies’s (UTC) $62.6 billion revenues. ^[1] We currently have a stock price estimate of $121 for UTC, around 5% ahead of its current market price.

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Weak Defense Spending From The U.S. Will Temper Growth In Sikorsky’s Results

In 2013, Sikorsky generated 58% of its sales from the U.S. government. ^[1] These sales from the government were largely related to new shipment and aftermarket part sales for military helicopters like the UH-60 Black Hawk. However, with the war in Afghanistan coming to an end, operational usage of aircraft including helicopters is falling. In addition, the number of helicopters that are active in the war zone is coming down. This is directly impacting the demand for military helicopter spares. As a result, Sikorsky’s military aftermarket spare part sales have declined steadily since 2012. Last year, they contracted by 37% annually. ^[2]

At the same time, due to budget constraints and spending limits imposed by the Budget Controls Act of 2011, U.S. government’s defense spending is expected to remain weak for the coming decade. This will impact shipments of new military helicopters to the U.S. government, weighing on Sikorsky’s original equipment sales.

On the bright side, there are a couple of potential military contracts in the pipeline for Sikorsky. Later this year, the company is likely to sign the $7-10 billion contract for Air Force Combat Rescue helicopters for which it has partnered with Lockheed Martin (NYSE:LMT). It is also a front runner in the Presidential Helicopter contract that is valued at around $3 billion. ^[2] This contract is also expected to be awarded by the government sometime this year. In our opinion, these two new contracts will partially offset the impact on Sikorsky from the lower U.S. defense spending.

Offshore Oil Rig & International Military Demand Will Drive Long Term Growth In Sikorsky’s Results

Separately, the remaining portions of Sikorsky’s business – international military helicopter sales and commercial helicopter sales – are expected to grow strongly over the coming years. The company expects its sales from the international military market to grow in double digits and those from the commercial helicopter market to grow in mid-single digits through the end of this decade. As a result, by 2020, Sikorsky’s dependence on the U.S. government will fall from currently over half of its total sales to nearly a third of its sales. ^[2]

Defense spending from Asia is expected to grow by 55% over the next five years, according to figures cited by Sikorsky in its latest analyst presentation. ^[2] This will produce a large growth opportunity for military helicopter makers including Sikorsky. In our view, the company with its H-60 Black Hawk franchisee will hold a leading position in the global military helicopter market in the coming years.

At the same time, the demand for commercial helicopters from offshore oil rigs is growing driven by increasing demand for oil worldwide. Sikorsky with its S-76 and S-92 commercial helicopter franchisees occupies a leading position in this market as well. Currently, the company generates nearly two-third of its total commercial helicopter business from offshore oil rigs. With growing demand for oil, especially from the emerging countries, demand for helicopters that ferry personnel to offshore oil rigs will likely continue to grow.

Additionally, Sikorsky has formed strategic partnerships with large local companies in a few key markets to augment its growth. For instance, in China it has acquired interest in AVIC (Aviation Industry Corporation of China), while in India, it has partnered with the Tata Group in a joint venture that produces cabins for its S-92 helicopters. Production volume from the Tata joint venture nearly doubled last year driven by growing demand from India, and it is expected to continue to grow this year. ^[2]

In all, Sikorsky holds a leading position in the global helicopter market with its H-60, S-76 and S-92 product lines. Looking ahead, the company is targeting to add a fourth pillar to its business with the introduction of CH-53K helicopter, which is expected to eventually become larger than the UH-60 Black Hawk franchisee. With these four strong product franchisees, we figure Sikorsky is well positioned to compete with other major helicopter makers such as AgustaWestland, Eurocopter Group and Bell Helicopter. In our view, in spite of weakness from the U.S. defense market, Sikorsky will likely grow its results in the long term driven by commercial and international military helicopter demand.

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1. UTC’s 2013 10-K, February 6 2014, www.utc.com [↩] [↩] [↩] [↩]
2. Sikorsky’s address at the annual UTC analyst meet, March 14 2014, www.utc.com [↩] [↩] [↩] [↩] [↩] [↩]