Raytheon Technologies: Commercial Aerospace Remains Strong

A normalization of air travel should continue to provide tailwinds to the company

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Nov 21, 2022
Summary
  • Shares of Raytheon Technologies have greatly outperformed the industrial sector and the market as a whole.
  • Air travel is not yet back to pre-Covid-9 rates, but it is getting closer.
  • Defense is still lower year over year, but the company's backlog is massive.
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Raytheon Technologies Corp. (RTX, Financial) has gained more than 9% over the last year, which compares extremely well to the 15.3% decline in the industrial sector and the 17.1% drop for the S&P 500 Index.

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This is despite the company reporting five consecutive quarters of beating analysts’ estimates for earnings, but missing on revenue.

Raytheon Technologies has enjoyed a much better 2022 than the market as a whole and its sector in particular for two reasons: commercial aerospace demand is returning to pre-Covid-19 levels and defense spending around the world is higher.

Let’s dig deeper into the most recent quarterly report to see why Raytheon Technologies is one of my favorite names in aerospace and defense industry.

Earnings highlights

Raytheon Technologies reported third-quarter results on Oct. 25. As stated, results were mixed. Revenue grew 4.6% to nearly $17 billion, but this was $250 million below what the market had anticipated. Organic revenue grew by 6% for the period.

On the bottom line, adjusted earnings per share of $1.21 were lower than the $1.26 the company produced in 2021, but 7 cents better than expected.

The real standout business segments were those that dealt with commercial aerospace. Collins Aerospace, which makes everything that is used on airplanes, from toilets and wheels to power control and connectivity solutions, grew 11% to $5.1 billion. Organic sales improved 13%, driven by a 25% increase in commercial aftermarket and 16% growth in original equipment.

Pratt & Whitney, which manufactures engines mostly for narrow-body airplanes, saw even higher growth, with sales increasing 14% to $5.4 billion. Organic sales grew 15% with a 26% increase in commercial OE and a 23% improvement for commercial aftermarket.

As has been the case, the defense aspect of the company was the weaker performer.

Raytheon Missiles & Defense, the worst performer of the major segments, had a revenue decline of 6% to $3.7 billion. Organic growth fell 5% and operating profit was down 15%. While there were declines in certain areas, such as air defense, supply chain constraints also limited the performance of this segment.

Raytheon Intelligence & Space decreased 3% to $3.6 billion due to lower volumes in tactical communications systems and program that was only partially offset by an increase in classified projects. Organic growth was lower by 2%, while operating profit declined 5%.

Circling back to Collins Aerospace and Pratt & Whitney, the defense components of these segments fell 6% and 2%, respectively.

Raytheon Technologies provided a revised outlook for the year as well. The company now expects revenue of $67 billion to $67.3 billion, which compares to prior guidance of $67.75 billion to $68.75 billion. Adjusted earnings per\ share are forecasted to be in a range of $4.70 to $4.80 for 2022, compared to $4.60 to $4.80 previously.

Takeaways

The main takeaway from the third-quarter report is just how much better commercial aerospace is performing. Compared to 2019, air travel is still lower. North America is down 10% and Europe is lower by 18%. China remains the worst-performing region as Covid-19 restrictions have led to a nearly 50% decline in travel compared to the same period in 2019.

That said, international travel, which generally uses wide-body aircraft, is lagging domestic travel. U.S. travel was down a high single-digit rate from the same period of 2019. China is likely to remain an albatross for air travel as long as the country aggressively tries to stop the spread of the virus. Still, these two factors should not impact the company as much as Raytheon Technologies mostly addresses the narrow-body commercial market.

While air travel is not yet back to where it was prior to the pandemic, the double-digit improvement in OE and the over 23% gain in aftermarket services for both Collins Aerospace and Pratt & Whitey shows that demand in the industry is returning at a very fast pace. And these results were not against a favorable comparable period either. The third quarter of 2021 saw organic growth of 35% for Pratt & Whitney and 9% for Collins Aerospace.

Products and services are in much higher demand two years removed from the worst of the pandemic and the results in these businesses are indictive of the normalization of air travel. It is the primary reason that Pratt & Whitney and Collins Aerospace had operating profit growth of 68% and 31%, respectively, in the third-quarter.

Defense spending remains the weakest component of Raytheon Technologies. However, not all is lost. The ongoing war in Ukraine has led to higher spending on defense in both the U.S. and from NATO countries. Most recently, the Biden administration asked for a further $38 billion in defense aid to Ukraine, which would bring the total of U.S. spending on defense to over $100 billion for the nation.

European allies have also increased spending, but a lack of defense companies on the continent mean that the U.S. ones will have plenty of customers. For example, Switzerland, which had been a neutral country for five centuries, signed an agreement in September to order 36 F-35 fighter jets from Lockheed Martin Corp. (LMT, Financial). This is relevant and important to Raytheon Technologies as the company makes the engine for the F-35.

Demand has picked up in the defense focused segments as Raytheon Technologies received $22 billion in awards during the third quarter, resulting in a book-to-bill ratio of 1.32 for the period and 1.33 for the year to date.

Some of the awards include $1 billion for hypersonic missiles from the U.S. Air Force, $972 million for medium-range air-to-air missiles from the U.S. Airforce, Navy and international customers and $542 million for F-135 sustainment contracts.

The book-to-bill ratio in some of the defense segments ran ahead of the figure for the third quarter as the ratio for Missiles & Defense was 1.5, above the 1.33 year to date for the business. Intelligence & Space was 1.18 for the period, but was ahead of the year-to-date ratio of 0.97.

Defense spending is accelerating, but there is a natural lag between order placement and production as the manufacturing of defense products is a long process. It takes time to turn backlog into revenue, but Raytheon Technologies’ backlog increased $6 billion to $168 billion at the end of the quarter. Of this, $101 billion was from commercial aerospace and $67 billion was from defense.

For context, Raytheon Technologies generated revenue of just over $64 billion in 2021. The massive backlog, which is almost three times annual sales, reflects the strength in both markets the company addresses, but this is especially true for commercial aerospace.

One last point in the company's favor is that Raytheon Technologies offers a market-beating dividend yield of 2.3% and has a dividend growth streak of 28 consectutive years dating back to its time as United Technologies.

Final thoughts

The improvement in commercial aerospace is likely the driving force behind the company’s solid 2022. Because of this, shares of Raytheon Technologies are trading at a slight premium to fair value according to the GF Value chart.

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Presently, shares are trading nearly 5% above its GF Value.

The defense businesses are seeing small revenue declines, but worldwide conflict has upped the demand for spending even if this has not yet translated to present day revenue.

More importantly, the company is benefiting from a return of air travel as these segments are growing at a double-digit rate against difficult comparable periods. These businesses are also the largest component of Raytheon Technologies. People are traveling at much higher rates, even if they are not yet back to 2019 levels completely.

Therefore, Raytheon Technologies could be a name to consider for those investors looking to capitalize on the further normalization of commercial air travel.

Disclosures

I am/we currently own positions in the stocks mentioned, and have NO plans to sell some or all of the positions in the stocks mentioned over the next 72 hours. Click for the complete disclosure