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RTX Corporation - Geared Turbofan Engine (GTF)
I last reviewed RTX Corporation (RTX) (formerly Raytheon Technologies Corporation) in this January 25, 2023 post at which time it had just released its Q4 and FY2022 results and FY2023 outlook.
Although I considered RTX's valuation fair, I refrained from adding to my exposure. I hoped to acquire shares at a later date at a more favourable valuation.
With the July 25 release of Q2 and YTD2023 results and revised FY2023 outlook, I now revisit RTX.
Business Overview
Investors unfamiliar with RTX should review the company's website and Part 1 Item 1 within the 2022 Form 10-K.
RTX consisted of the following 4 business segments:
- Raytheon Missiles & Defense
- Raytheon Intelligence & Space
- Collins Aerospace
- Pratt & Whitney
Effective July 1, 2023, RTX executed its business realignment and now officially operates as three business units.
- Raytheon
- Collins Aerospace
- Pratt & Whitney
2023 Investor Day
On June 19, RTX held its 2023 Investor Day. The following are the key takeaways.
Pratt & Whitney - Geared Turbofan Engine (GTF) Issue
On July 25, RTX surprised the investment community. It disclosed that its Pratt & Whitney (P&W) operating segment identified microscopic contaminants in a metal used in part of the Geared Turbofan (GTF) engines that power Airbus' popular A320neo jets. This resulted in a plummet in RTX's share price immediately following the earnings release.
As expected, most of the analysts' questions on the Q2 earnings call were related to the GTF issue!
The costs, work scope, and timing to rectify the GTF problem have yet to be determined. In the next 30 - 60 days, however, management anticipates being in a position to provide more details including the impact on cash flow. Currently, management expects an accelerated use of capital in that inventory will be required to get ready for the inspection of these GTFs. Furthermore, RTX will incur expenses to start performing work to rectify the faulty engines in Q4 2023.
The issue will not be resolved in FY2023 and it is premature to determine the impact of the faulty GTFs on FY2024 and FY2025 results.
Sale of Collins' Actuation And Flight Control to Safran
Recently, RTX announced that it had reached an agreement with France's Safran S.A. to divest Collins’ actuation business to Safran. Safran is a French multinational company that designs, develops and manufactures aircraft engines, rocket engines as well as various aerospace and defence-related equipment or their components.
This transaction is expected to close in the second half of 2024 with proceeds from the transaction being ~$1.8B.
As part of the deal, Collins will become a customer for 25% of Safran’s new activity, typically for nacelle actuators.
Financials
Q2 and YTD2023 Results
I provide links to RTX's Q2 Form 10-Q, Earnings Release, and Earnings Presentation released on July 25 so you can readily access the information to conduct your assessment.
Source: RTX - Q2 2023 Earnings Presentation
RTX experienced strong demand in both the commercial and defence segments with $25B of new orders. This brings RTX's total backlog to a record $185B.
On the commercial side, Collins continues to convert its industry-leading portfolio into solid order strength.
Industry-wide there were about 1,200 new aircraft orders announced at the 2023 Paris Air Show in June. The aggregate amount of Collins and Pratt content on those aircraft will be about $20B through the life of the programs.
On the defence side across the RTX businesses, there were $13B in net bookings in Q2, driving a strong book-to-bill of 1.22; the defence backlog is now $73B.
NOTE: A book-to-bill ratio measures supply and demand and represents the ratio of orders received to units shipped and billed for a specified period. When this performance and outlook ratio exceeds one, the implication is that more orders were received than filled (strong demand). Where the ratio is below one, the implication is that there is weaker demand.
FY2023 Outlook
RTX has revised its FY2023 outlook.
The impact of the GTF matter will be more meaningful on cash flow as RTX begins to ramp up inspections and Maintenance, Repair and Operations (MRO) activity in the second half of FY2023. As a result, RTX's FY2023 FCF forecast is ~$4.3B which is ~$0.5B below the prior outlook.
Source: RTX - Q2 2023 Earnings Presentation
Source: RTX - Q2 2023 Earnings Presentation
Credit Ratings
The average maturity of RTX's long-term debt at the end of Q2 is ~14 years. Detail of RTX's long-term debt commences on page 13 in the Q2 2023 Form 10-Q.
Long-term debt (LTD) that matures in FY2024 - FY2027 amounts to ~$1.25B, ~$1.5B, ~$1.22B, and ~$2.917B. I do not foresee an issue with RTX repaying its obligations.
Moody's currently assigns a Baa1 rating to RTX's senior unsecured domestic currency debt. This is the top tier of the lower medium-grade category.
This rating defines RTX as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to meet its financial commitments.
S&P Global continues to assign an A- rating with a negative outlook. This rating is one notch higher than that assigned by Moody's and is the lowest tier of the upper-medium grade category.
S&P's rating defines RTX as having a STRONG capacity to meet its financial commitments. However, it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
Both ratings are investment grade and are acceptable for my purposes.
Dividend and Dividend Yield
When I wrote my January 26, 2022 post, shares were trading at ~$90. The quarterly dividend was $0.51 thus resulting in a ~2.27% dividend yield.
At the time of my July 27, 2022 post, the quarterly dividend was $0.55. With shares still trading at ~$90, the dividend yield was ~2.44%.
When I wrote my January 25, 2023 post, shares were trading at ~$97.60. I expected one more $0.55 quarterly dividend and then a ~$0.59 - ~$0.60 quarterly dividend commencing in mid-June. On this basis, the forward dividend yield using the current share price was ~2.4% ($0.55 + (3 x $0.595)).
As I compose this post, RTX's dividend history on its website is incorrect; every quarterly dividend payment in 2021 - 2023 is duplicated. The website reflects YTD dividend payments totalling $3.46. RTX, however, has only declared $1.73 in dividends in 2023 (refer to the bottom of page 8 in the Q2 2023 Form 10-Q).
Based on my recent $85.67 purchase price, the dividend yield is ~2.75% assuming the declaration of a $0.59 dividend in October 2023 and February 2024.
If RTX's historical dividend increases are an indication of what to expect in April, I envision a $0.63 dividend. On this basis, the next 4 quarterly dividend payments are likely to total $2.44 ((2 x $0.59) + (2 x $0.63)). The forward dividend yield using my purchase price is ~2.8%.
RTX's weighted average number of issued and outstanding shares in FY2010 - FY2022 (in millions rounded) is 923, 907, 907, 915, 912, 883, 826, 799, 810, 864, 1,358, 1,509, and 1,486. The diluted weighted average number of shares outstanding in Q2 2023 is 1,468.7.
The significant increase in RTX's outstanding shares in FY2020 is primarily due to the merger of United Technologies Corporation's aerospace business and Raytheon Company on April 3, 2020.
In the first 6 months of FY2023, RTX repurchased ~11,821 million shares for ~$1.158B of which $0.596B was repurchased in Q2.
On the Q2 earnings call, management indicated the plan remains to repurchase ~$3B of RTX shares in FY2023, subject to market conditions.
On June 30, 2023, management had the remaining authority to repurchase ~$4.8B of common stock under the December 12, 2022 share repurchase program.
Valuation
Please refer to my July 27, 2022 post in which I touch upon RTX's valuation at the time of previous RTX posts.
At the time of my July 27, 2022 post, the current forward-adjusted diluted PE valuations based on broker guidance were:
- FY2022: 17 brokers, mean estimate $4.71, low/high range $4.55 – $4.80. The valuation using the mean estimate is ~19 and ~18.8 using the upper end of the range.
- FY2023: 16 brokers, mean estimate $5.69, low/high range $5.18 – $6.21. The valuation using the mean estimate is ~15.8 and ~14.5 using the upper end of the range.
- FY2024: 11 brokers, mean estimate $6.54, low/high range $5.28 – $7.23. The valuation using the mean estimate is ~13.8 and ~12.4 using the upper end of the range.
I expected downward earnings revisions following my published post and cautioned that we would likely have higher valuations than those reflected above.
When I analyzed RTX in January 2023, shares were trading at ~$97.60 and management's FY2023 adjusted diluted EPS outlook was $4.90 - $5.05. This gave me a forward-adjusted diluted PE range of ~19.3 - ~20.
RTX's forward-adjusted diluted PE valuations based on broker guidance were:
- FY2023: 21 brokers, mean estimate $5.01, low/high range $4.68 – $5.24. The valuation using the mean estimate is ~19.5.
- FY2024: 20 brokers, mean estimate $5.85, low/high range $5.25 – $6.34. The valuation using the mean estimate is ~16.7.
- FY2025: 13 brokers, mean estimate $6.82, low/high range $6.26 – $7.56. The valuation using the mean estimate is ~14.3.
On July 25, I acquired 100 additional RTX shares @ $85.67/share. Using the $5 mid-point of management's revised FY2023 adjusted diluted EPS guidance of $4.95 - $5.05 (previously $4.90 - $5.05), the forward adjusted diluted PE is ~17.1.
RTX is in the process of defining the scope and the turnaround time required to work through the GTF issue. Defining the magnitude of the problem is to occur in Q3 and rectifying the issue will likely only commence in Q4. I am, therefore, prepared to use management's FY2023 adjusted diluted EPS guidance.
The valuation using current broker estimates and my $85.67 purchase price is as follows:
- FY2023: 23 brokers, mean estimate $5.01, low/high range $4.95 – $5.05. The valuation using the mean estimate is ~17.
- FY2024: 23 brokers, mean estimate $5.67, low/high range $5.10 – $5.89. The valuation using the mean estimate is ~15.
- FY2025: 16 brokers, mean estimate $6.68, low/high range $6.31 – $7.20. The valuation using the mean estimate is ~12.8.
Should RTX determines the GTF problem is more severe than anticipated and the FY2024 forward-adjusted diluted mean EPS is closer to $5.25, then the forward-adjusted diluted PE is ~16.3. This is still a reasonable valuation for a company that plays a critical role in the aerospace and defence sectors.
Final Thoughts
I initiated a United Technologies (UTX) position on April 18, 2008 within a retirement account. Over the years I have benefited from the spin-off of OTIS Worldwide Corporation (OTIS) and Carrier Global Corporation (CARR) from UTX and the subsequent merger of UTX with Raytheon Company on April 3, 2020.
When I completed my January 2023 Investment Holdings Review and Mid 2023 Investment Holdings Review, RTX was not a top 30 holding; it was my 24th largest holding when I completed my Mid 2022 Investment Holdings Review. It very likely is still not a top 30 holding despite my July 25, 2023 purchase of 100 shares @ $85.67/share.
I am looking to increase my exposure to great companies that are experiencing what I consider to be short-term headwinds. RTX is such a company.
RTX's financial results will be negatively impacted over the next several quarters; the $0.5B downward revision in RTX's FY2023 FCF outlook is an indication of the magnitude of how costly it will be to resolve the GTF issue. Investors, however, need to step back and look at the big picture. RTX is a critical aerospace and defence company that provides advanced systems and services for commercial, military and government customers worldwide. It is highly unlikely this will come to a sudden end as evidenced by the recently awarded contracts and the record backlog.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long RTX, OTIS, and CARR.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
