Raytheon Technologies Corporation (RTX, Financial) recently reported earnings results for the second quarter of 2020. This was the first quarter following the Carrier (CARR, Financial) and Otis (OTIS, Financial) spinoffs and the merger of Raytheon and United Technologies to form Raytheon Technologies. Raytheon Technologies now consists of Collins Aerospace, Pratt & Whitney, Raytheon Intelligence & Space and Raytheon Missiles & Defense.
I've stated in previous articles that the aerospace and defense sector remains among my favorite places to invest due to higher spending on defense in both the U.S. and abroad. In this article, we will look at the recent quarter and valuation to determine if shares of Raytheon Technologies can provide solid returns at the current price.
Quarterly highlights
Raytheon Technologies released earnings results on July 28. The company's revenue totaled $14.1 billion, which was $676 million higher than the analyst community had expected. Adjusted earnings per share was 40 cents, topping expectations by 28 cents. As the second quarter of 2019 included Carrier and Otis, but not the Raytheon businesses, year-over-year comparisons for the top and bottom-line are not useful.
Collins Aerospace sales declined 35% year over year to $4.2 billion. Organic sales declined 36%, which the company primarily attributed to Covid-19. Commercial OEM was hit especially hard as sales were down 53%. Commercial aftermarket decreased 48%. Both businesses suffered declines due to fewer flight hours, commercial OEM deliveries and aircraft utilization. Military sales, which increased 10%, were a bright spot as higher volumes for the F-35 and defense development programs helped offset declines in commercial aerospace.
Revenues for Pratt & Whitney were down 30% to $3.5 billion. Organic sales were down 32%. As with Collins Aerospace, Pratt & Whitney struggled due to the ongoing pandemic. Commercial OEM was down 42% while commercial aftermarket was lower by 51%. Military sales increased 11% due to F-35 production and aftermarket services for multiple fighter jet programs.
Raytheon Intelligence & Space generated pro forma sales of $3.3 billion during the quarter, which was a 5.7% decrease from the previous year. Airborne system sales were higher and this segment saw gains across most programs. This segment had $1.4 billion of classified bookings in the quarter and $166 million of bookings for the U.S. Air Force.
Raytheon Missiles & Defense had sales of $3.6 billion on a pro forma basis. This was 5.3% lower than the prior year. International air and missile defense systems remain in high demand from customers. This segment had $300 million in bookings for missile systems.
Adjusting for the number of days in the quarter, sales for Raytheon Intelligence & Space increased 1% while Raytheon Missiles & Defense grew 3%.
Commercial aerospace and aftermarket services will likely be challenged moving forward. Aftermarket services, which are a very high margin business, were especially weak. Depending on the engine model, aftermarket revenues were down 60% to 80% in the quarter. Fortunately for Raytheon Technologies, the Pratt & Whitney segment has no exposure to the 737 MAX and the associated delays with that aircraft.
While commercial aerospace is facing headwinds due to Covid-19, defense looks to remain strong. The book-to-bill ratio was 1.2 for the defense businesses. The total backlog stood at almost $159 billion as of the quarter's end, with $85.6 billion for commercial aerospace and $73.1 billion for defense. The defense backlog was a new record.
The company also updated investors on the merger. Merger integration and synergies remain on schedule. Already $600 million of savings were achieved in the second quarter, which is roughly a third of what Raytheon Technologies expects to see in cost savings. The company expects $2 billion in cost savings related to the merger in 2020 with 30% coming in the third quarter and the remainder in the fourth quarter.
Raytheon Technologies ended the first half of the year with $42.3 billion of current assets, with nearly $7 billion in cash and equivalents. This compares favorably to current liabilities of $35.3 billion. Total debt stands at $34.5 billion, with $1.5 billion due within a year.
Value line
According to analysts surveyed by Value Line, Raytheon Technologies is expected to achieve EPS of $3.90 in 2020. This gives the stock a forward price-earnings ratio of 15.5 using Friday's closing price of $60.27. The average price-earnings ratio since 2010 was 16.1 for the legacy United Technologies.
I have a target valuation range of 16 to 18 times earnings for Raytheon Technologies. This is slightly below my target valuation range for Lockheed Martin (LMT, Financial), which is my favorite name in the sector. The reason for my lower valuation target range is that Raytheon Technologies has exposure to commercial aerospace whereas Lockheed Martin is more of a pure play defense company.
Using the above assumptions, I have a price target range of $62 to $70 for the stock. Trading within this range would result in a 3% to 16% gain from the most recent closing price.
Raytheon Technologies also pays a 3.2% dividend yield at the moment. The stock would yield 3.1% at the low end of my price target range and 2.7% at the high end. In total, investors could see 6.1% to 18.7% total returns from Raytheon Technologies.
Final thoughts
Raytheon Technologies topped estimates for both revenue and EPS for the first quarter that all four components of the newly formed company reported results together. Certain areas, like commercial aerospace, were weak, but that was largely outside of the company's control. On the other hand, the military and defense businesses remain strong.
A very bullish sign is that Raytheon Technologies' backlog remains massive. Based on second quarter revenues, it would take the company nearly three years to work off its current backlog, and that's without any additional bookings.
Shares of the company trade just below the low end of my price target range, but shareholders could see high double-digit returns if the multiple were to expand. Investors looking for an entry point into Raytheon Technologies could do very well buying the stock at its current price.
Author disclosure: the author has a long position in Raytheon Technologies and Lockheed Martin.
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