Is Raytheon Stock A Buy, Sell, Or Hold After Recent Earnings?

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Raytheon Technologies Corp. (NYSE:RTX) just reported its latest quarterly result highlighted by an earnings beat benefiting from a broad post-pandemic recovery in commercial aviation. This was a closely watched report for the aerospace & defense industry giant given its position as a U.S. military and allied forces supplier.

The reality is that geopolitical conflicts and military escalations are good business for Raytheon, which is part of the stock’s bullish thesis. The Russia-Ukraine conflict is expected to boost demand for key weapons systems and warfare technologies driving growth going forward. Amid the ongoing market volatility, we believe RTX can emerge as a winner supported by several underlying tailwinds.

Raytheon Earnings Recap

Q1 non-GAAP EPS of $1.15 climbed 28% from the period last year and was $0.13 above the market consensus. Revenue of $15.7 billion climbed by 3.1% year-over-year, although this was slightly below the estimate. The story this quarter was the strength on the aerospace side balancing some weakness in the defense group, which has not yet incorporated the more recent developments.

source: company IR

By segment, “Collins Aerospace” and the “Pratt & Whitney” businesses led growth with adjusted sales up 10% and 12% each respectively. An ongoing rebound in industry air traffic translated to strong demand for commercial aftermarket parts including maintenance and new aircraft production. The company’s version of operating margin with the return on sales (ROS) metric was sharply higher for both groups which added to firm-wide profitability.

On the other hand, management noted ongoing supply chain constraints as limiting sales in the “Intelligence & Space” and “Missiles & Defense” segments where adjusted revenue each declined by -5% and -7% y/y. The weaker top-line pressured margins leading to a lower segment operating profit although it remains positive for both segments.

source: company IR

An important update from Raytheon is the company’s decision to completely exit the Russian market. This includes exposure to aircraft maintenance parts that would normally supply the country’s commercial fleet along with the indirect impact of no longer shipping engines to manufacturers like Airbus SE (OTCPK:EADSY) which was previously expected to deliver new aircraft into Russia.

The result is a small revision lower to the company’s full-year sales guidance to a range between $67.75 billion and $68.75 billion, compared to a prior midpoint estimate of $69 billion. That said, management is reiterating its 2022 EPS target of $4.60 and $4.80 which it believes it can achieve through an effort in cost reductions and other efficiencies. If confirmed, the 2022 adjusted EPS guidance represents an increase of 10% compared to 2021.

source: company IR

Raytheon Dividend Increase

Ahead of the earnings release, Raytheon hiked its quarterly dividend by 8% y/y to a new quarterly rate of $0.55 per share. The stock’s current forward yield is 2.2%. Including the dividend history from the legacy “United Technologies” that combined with Raytheon in 2020, RTX is a Dividend Aristocrat with a 28-year history of annual dividend increases.

Looking at RTX’s dividend coverage, it represents an annual payout of around $3.3 billion which we view as well supported by underlying earnings and compares to guidance for 2022 free cash flow near $6.0 billion. Separately, management also intends to buy back approximately $2.5 billion in stock this year.

The capital allocation plan is backed by an overall solid balance sheet. RTX ended the quarter with $6.0 billion in cash and equivalents against $31.3 billion in long-term debt. Considering EBITDA of $11.3 billion over the past year, we calculate a net debt to EBITDA leverage ratio of 2x, a relatively strong level within the industrials sector.

What To Expect After Earnings

The first point to highlight is that RTX has outperformed the broader market, up 15% year-to-date compared to a 12% decline from the S&P 500 (SPY). The stock has been in an upward trend over the past year, largely following the improved outlook for air travel and aircraft manufacturing. The Russia-Ukraine war is a new dynamic that adds another layer of positive sentiment toward the stock.

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What we like about RTX is its diversification across aerospace and defense including the more vanilla civilian aviation exposure and the more high-profile weapons systems. The company’s “Javelin” anti-tank guided munition has made headlines as a key piece of equipment being used by Ukrainian forces. There is also the “Stinger” anti-aircraft missile that is recognized as a highly effective defense against low flying aircraft, helicopters, and even jets and other missiles being used in Ukraine. The U.S. has provided these systems as part of its support to the country.

During an interview in March, Raytheon’s CEO explained that much of the weapons sent to Ukraine are from existing stockpiles held by the U.S. Department of Defense. By this measure, while their utilization wasn’t reflected in their latest financials, the expectation is for new orders to rebuild those inventories through next year.

In the near term, there is a challenge related to supply chain disruptions for key manufacturing inputs necessary to scale Stinger and Javelin production. The company intends to redesign some components related to electronics as a workaround based on material availability. Nevertheless, the outlook is for a more positive growth contribution going forward. This point was covered by management in the earnings conference call:

We’ll ramp up production what we can this year, but I would expect, again, this is going to be a ’23, ’24 where we actually see orders come in for the larger replenishments, both on Stinger as well as on Javelin, which has also been very successful in theater.

It’s important to recognize that the “Missiles & Defense” segment has a wide variety of in-demand products like radars, counter-drones, naval warfare, and projectiles. All this is on top of the existing segment backlog of $29 billion.

According to consensus estimates, the forecast is for 2022 revenue growth of 7% which is in line with the current guidance while the market is expecting EPS in the upper range of management’s target of $4.80. Looking ahead, the expectation is for revenue growth to average 8% in 2023 and 2024 while accelerated earnings can benefit through higher margins. Our view is that these forecasts may end up being too low particularly if Raytheon’s Missiles & Defense group gains sales momentum.

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Is Raytheon Stock A Fair Valuation?

As it relates to valuation, RTX trading at a 21x forward P/E ratio on its 2022 consensus EPS represents a small premium to a group of large-cap peers like General Dynamics (GD) at 20x, Northrop Grumman Corp (NOC) at 18x, and Lockheed Martin Corp (LMT) at 16x. In terms of the EV to forward EBITDA ratio, RTX at 14x is around the average for the group.

Based on these metrics alone, RTX doesn’t necessarily stand out as undervalued but we make the case that it deserves a valuation premium given its scale and high-quality profile. The company also benefits from its diversification while some of the other peers are more focused on particular areas within the defense sector.

source: Ycharts

Is RTX Stock A Buy, Sell, Or Hold?

We rate RTX as a buy with a year-ahead price target of $120 per share representing a 25x forward P/E on the current consensus 2022 EPS. Our call here considers that the strength in commercial aviation will continue while Raytheon is also well positioned to capture a boost in demand for defense systems amid the current geopolitical environment.

Whether or not the Russia-Ukraine conflict escalates, the understanding is that the U.S. and NATO forces are on a long-term strategic pivot to strengthen their military footprint and stockpile equipment for the future. In other words, we make the case that the long-term outlook for Raytheon is stronger than ever.

The main risk to consider for the stock in the near term will come down to sentiment. Some type of near-term resolution in Ukraine would likely add volatility to the stock beyond the actual financial impact. Over the next few quarters, trends in defense segment sales along with the firm-wide operating margin are key monitoring points.