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Why Margins in UTX’s Otis Segment Should Be Tight on Chinese Overhang

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Jul. 7 2016, Updated 5:07 p.m. ET

The decline in China

United Technologies’s (UTX) Otis segment, which accounts for ~20%–22% of the company’s revenues every year, is the world’s largest elevator manufacturer. This segment has the best margins of the company’s operating units. It contributes ~29% to the company’s total operating income, a larger share compared to its revenues.

China is the world’s largest elevator market, accounting for approximately 60% of global new equipment sales every year.

With the explosion of real estate (XHB) in China, the country became a phenomenal growth engine for the unit for over a decade. However, as the tide turned in 2015, a slowing Chinese economy has cast a shadow on Otis’s ability to make further advances in the region.

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Competitive challenges for Otis

As orders in China contract, companies such as Schindler, Thyssenkrupp AG, Kone, and Otis are engaging in an intense sales battle to gain market share in the country at the expense of price. Local manufacturers such as Toshiba Elevator (TOSYY) and Hitachi Elevators (HTHIY), which mainly compete on price, are further dragging margins southward.

Excess housing (ITB) inventory in Tier 3 cities in China stand at twice the levels in Tier 1 and Tier 2 cities. This presents a formidable challenge for companies looking to increase their inroads in these regions.

Margins are so low that some manufacturers, such as Finland’s industry leader Kone Corporation, declined orders rather than compete on price. Investors should keep a close watch on the effect of the Otis segment’s declining margins on its upcoming earnings results.

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