RTX stock is not cheap, but it still might be a buy.
RTX Corporation (RTX -0.48%) reported big earnings beats on both the top and bottom lines in its earnings report last week, and the crowd went… mild.
Shares of one of America’s biggest defense contractors, that closed at $101.38 on the evening before earnings, ended the week up just $0.03, three-hundredths of 1%, at $101.41.
Are you not entertained?
It gets an investor to wondering.
RTX reported $19.3 billion in Q1 2024 sales, up 12% from Q1 2023. Its earnings growth was even better, a 32% year-over-year improvement at $1.28 per diluted share. And of course, because profit went up faster than sales, you know that RTX had to have reported better profit margins as well. Those were up 60 basis points at a very respectable 8.9%.
So why, with so much good news, did RTX’s share price barely budge — and did RTX stock deserve better?
Let’s dig in and find out.
The big headline: Defense
RTX, formerly known as Raytheon and now possessing a weapons division by that name, is of course one of America’s biggest defense contractors. So as you might expect, “defense” was a big part of the story of how RTX crushed its Q1 earnings report.
Consider: $1.6 billion of “classified bookings,” $1.2 billion of Patriot anti-air defense systems sold to Germany, and $282 million worth of National Advanced Surface-to-Air Missile Systems delivered to Ukraine. These were just a few of the sales figures RTX highlighted in last week’s report, all part of a business that did $6.6 billion in sales last quarter and helped RTX to build a $202 billion backlog of future work to be done.
Yet while everyone on Wall Street was watching RTX’s Raytheon defense unit this past quarter, the company’s more civilian divisions, Collins Aerospace and Pratt & Whitney, silently stole the show.
Collins and Pratt — RTX’s secret weapons
The Raytheon defense division may have posted RTX’s best profit margin of Q1, at 15%, but its sales actually grew a bare 6% year over year — which seems kind of underwhelming given the number of conflicts springing up around the globe. In contrast, RTX’s Collins Aerospace division, which manufactures plane parts, grew its sales 9%, and RTX’s Pratt & Whitney airplane engines division grew 23% year over year.
Now, not all the news was good. In contrast to Raytheon, where operating profit margin leapt nearly six full percentage points year over year to 15%, margins at both Collins and Pratt & Whitney declined — and not by a little. Collins’ profitability fell 200 basis points to 12.7%; Pratt & Whitney margins slid 150 basis points to 6.4%.
That’s a problem for Raytheon because, with all three divisions reporting roughly equal revenues in the quarter, it means two thirds of these equal-sized divisions are getting less profitable while only one is getting more profitable. But it’s also an opportunity.
Collins and Pratt & Whitney are growing so much faster than Raytheon, you see, that if they can only just keep their margins steady, profits should grow nicely for the company. And of course, any improvement in profit margins at all would turbocharge that profits growth.
Is RTX stock a buy?
And RTX says margin will improve. 2024 financial guidance anticipates total sales growth of 14%, and a potential doubling of earnings to more than $5.25 per share. (RTX gave only “adjusted” earnings guidance, so it’s not 100% certain what this will mean in GAAP terms). And the fact that RTX cited higher research and development spending (a necessary precursor to growth) as one reason margin was down in the first place has me thinking that RTX is making the right moves to deliver on its growth promises.
Granted, I’m less than enthusiastic on this stock’s valuation. Historically, RTX stock has averaged about 21 times earnings and 1.6 times sales in valuation, according to data from S&P Global Market Intelligence. Currently, the stock costs closer to 40 times trailing earnings, and 1.9 times trailing sales, both of which imply overvaluation. Still, if RTX bounces back as quickly as it’s promising, and continues growing from there — as both the R&D spending and the global threat environment suggest it might — even these rich multiples to sales and earnings may be justified.
RTX stock probably isn’t my top pick among defense stocks. If given enough time, it might reward investors anyway.