The commercial aerospace and defense giant just raised its full-year guidance, and its backlog stands at a new record.
It’s been a great year for commercial aerospace and defense company RTX (RTX -0.64%). The company has dispelled the worst fears over the geared turbo fan (GTF) engine inspection issue, and management recently raised its full-year revenue and earnings guidance. That said, is the stock still a good value? Here’s what you need to know before buying RTX stock.
RTX stock: The headline numbers
Before discussing the business qualitatively, here’s a brief overview of management’s recently upgraded guidance. As you can see in the table below, management raised its sales and earnings guidance but cut its free cash flow (FCF) guidance. There will be more on that in a moment.
|
Full-Year Guidance |
January |
April |
July |
|---|---|---|---|
|
Sales |
$78 billion to $79 billion |
$78 billion to $79 billion |
$78.75 billion to $79.5 billion |
|
Organic sales growth |
7% to 8% |
7% to 8% |
8% to 9% |
|
Adjusted EPS |
$5.25 to $5.40 |
$5.25 to $5.41 |
$5.35 to $5.45 |
|
Free cash flow |
$5.7 billion |
$5.7 billion |
$4.7 billion |
Data source: RTX presentations.
RTX operates out of three segments: Collins Aerospace, Pratt & Whitney (engines and aftermarket), which are mainly focused on commercial aerospace, and Raytheon, a defense-focused business. The excellent news is that RTX is seeing strong growth in its commercial original equipment (OE) and commercial aftermarket sales (both sales channels are in Collins and Pratt & Whitney), as well as its defense business (which crosses all three segments).
For the second quarter, RTX reported 19% year-over-year growth in commercial OE sales as airplane demand remained high. In addition, commercial aftermarket sales were up 14% as flight departures continued to grow. Finally, excluding the divestiture of a cybersecurity business, RTX’s defense business sales were up 7% as it executed on its record backlog.
RTX’s growth engine
There’s more growth to come. RTX reported $24 billion in awards in the quarter and had a book-to-bill ratio of 1.25. Its backlog surpassed $206 billion. Based on the guidance for sales in 2024, RTX’s backlog represents 2.6 years’ worth of sales.
GTF inspections on track
Moreover, there was good news on the troublesome issue of GTF engine inspections. RTX is removing and inspecting engines potentially affected by a rare occurrence of contaminated powder coating used in manufacturing its GTF engines.
CEO Chris Calio’s update was good: “We have inspected over 6,000 powder metal parts that are in the field across all programs, and the associated fallout rate remains below the 1% we had assumed. The findings are consistent with the assumptions that underpin our fleet management plan.”
As such, it’s reasonable for investors to expect no more than the $3 billion cash headwind in 2023-2025 that management previously estimated.
With the commercial aerospace market in growth mode in both OE and the aftermarket, ongoing strength in defense spending, and a record backlog, RTX has excellent earnings momentum.
Image source: Getty Images.
Defense company margins?
While RTX undoubtedly has good near-term prospects, a few factors might still hold its share price back.
First, there are ongoing questions about what kind of margin defense companies can command in the future, and the reduction in the 2024 FCF guidance, as outlined above, illustrates that. Management reduced its FCF guidance by $1 billion this year due to the need to pay to resolve three issues relating to its defense business: Namely, “defective pricing claims” on legacy contracts, “voluntarily disclosed export controls compliance matters,” and “improper” payments made in relation to Middle East contracts.
In addition, terminating a fixed-price development contract has a $0.5 billion cash impact (offset by a $0.5 billion improvement in tax payments).
These issues highlight the difficulties in growing margins in the defense industry when the U.S. government appears to be getting much more demanding in negotiations, and international contracts bring other risk elements.
RTX valuation
Second, even accepting that the cash impacts in 2024 can be seen as a one-off event, RTX’s cash flow-based valuation doesn’t make the stock look particularly cheap. For example, management expects $7.5 billion in FCF in 2025, putting it at 20.3 times the estimated 2025 FCF.
That’s fine, but it doesn’t leave the stock looking notably undervalued, particularly if the margin pressures felt by many companies in the defense industry turn out to be structural issues that won’t go away anytime soon.