Raytheon stock: healthy fundamentals but fully valued (NYSE: RTX)

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Thesis

Raytheon Technologies (NYSE:RTX) reported strong results for the first quarter of 2022 on April 26, 2022. Revenue and net income showed healthy growth amid supply chain disruptions and shutdown of defense activities with Russia. Sales have arrived to $15.7 billion, representing annual growth of 3% and organic growth of 4%. GAAP EPS was $0.74, representing a 45% year-over-year increase, but note that $0.41 of EPS was due to acquisition accounting adjustments and significant net charges and /or non-recurring.

Looking ahead, business fundamentals remain strong as travel business normalizes and global defense budgets continue to expand, especially given the situation between Russia and Ukraine. Although there are also some uncertainties ahead. The company adjusted its sales guidance to $67.75-68.75 billion, down about 1% from its previous guidance of $68.5-69.5 billion, mainly due to sanctions world against Russia. Other factors such as supply chain issues, inflation and labor cost will linger and add another layer of uncertainty to its operation.

In terms of valuation, the stock has reached its full valuation and therefore there is little safety margin at its current level.

Considering the pros and cons above, our final verdict is a hold rating under current conditions.

Solid business fundamentals, but some challenges

RTX Q1 2022 results are generally positive. The takeover of Collins Aerospace is a highlight and a major contributor, with revenue up 10% to $4.8 billion. Growth in the commercial aftermarket was particularly strong, at 39%. As CFO Neil Mitchill commented (emphasis added by me):

As Greg noted, we achieved adjusted earnings per share and free cash flow that exceeded our expectations for the quarter. Sales of $15.7 billion were in line with our expectations and up 4% organically from the prior year. Our performance during the quarter was mainly driven by the continued recovery in short-haul domestic and international air travel, partially offset by continued supply chain constraints across our businesses. Adjusted earnings per share of $1.15 was up 28% year-over-year and beat our expectations, driven primarily by Collins’ trading secondary market at $0.04 of equipment trading calendar origin to Pratt and other elements of the business, including a lower tax burden, which more than offset supply chain constraints.

Note that the 28% year-over-year adjusted earnings per share growth reported by Mitchill was different (and significantly lower) than the 45% growth rate in GAAP EPS terms, as mentioned above. And again, this is due to the EPS adjustment of $0.41 due to accounting adjustments.

Going forward, the conflict in Ukraine will continue to impact its short-term income. The halt in business activities with Russia led to a decline in the full-year outlook of $750 million, to a range of $67.75 billion to $68.75 billion, from its previous forecast. . And as a result, its organic growth rate guidance is also lowered to the 6-8% range, 1% below its previous guidance range of 7%-9%. However, I would consider an organic growth rate of 6% (let alone 8%) to be very healthy for such an important title. And free cash flow is also expected to hit a healthy $6 billion.

Expanding our horizon a bit, I am optimistic that its defense segments will enjoy more long-term secular support, as the Russian-Ukrainian situation has unfortunately heightened global national security awareness and triggered a new round of increases in the defense budget. For example, its Intelligence & Space segment recorded an order-to-bill ratio of 0.80a and a total backlog of $17 billion. Its Missiles and Defense segment boasts an even larger backlog of $29 billion and an even higher book-to-bill ratio of 1.18. Such a backlog and long-term government support will ensure stability and revenue growth for years to come.

Contemporary issues such as travel resumption, supply chain issues, inflation, and labor costs may add another layer of uncertainty to its near-term operation. But I only see these problems as temporary. In particular, on the issue of inflation, defense budgets have historically grown faster than long-term inflation. And major defense contractors like RTX have demonstrated their ability to keep up with inflation without issue. Additionally, travel may not recover as quickly as RTX hopes. But the company maintains that strong momentum in aftermarket parts and services is a more indicative signal.

Highlights of Raytheon 1Q 2022

RTX First Quarter 2022 Earnings Report

Environment Raytheon 2022

RTX First Quarter 2022 Earnings Report

Evaluation and projected performance

In terms of valuation, RTX has reached full valuation and I don’t see a significant margin of safety here. As the first chart shows, in terms of dividends, the valuation is currently around 5% above its historical average. In terms of price/cash ratio, it is currently valued at 12.5x, a discount of around 4% from its historical average of 13x. Overall, I consider these levels of deviations to be easily within the margin of error.

Compared to its peers like Lockheed Martin (LMT) and General Dynamics (GD), it is trading at a substantial premium, as you can see on the second chart. Its FY1 PE of 20.2x is more than 20% higher than LMT and nearly 10% higher than GD. Core metrics such as price to sales or EV to sales ratio also indicate a significant valuation premium. Certainly, it enjoys more diverse revenue streams, made up of both civilian and military segments. However, I consider the defense segment itself to be stable enough already and the higher premium is hard to justify.

Valuation and security of Raytheon shares

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RTX Valuation vs. LMT vs. GD

Looking for Alpha

With the full valuation, the projected returns in the next few years are limited. For the next 3 to 5 years, an annual growth rate above single digits is expected (around 6.5%). And the total return is expected to be in the range of 22% (the low projection) to about 34% (the high end projection), translating into an annual return of 5% to 7.5%. Not the most spectacular returns, but still solid, especially when adjusted for its A+ financial strength and consistency in earnings.

Raytheon Return Screenings

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Final thoughts and risks

RTX had a strong quarter with healthy revenue and net income growth despite various headwinds ranging from supply shortages to a weaker travel recovery. For the future, I see the problems as temporary. And I’m particularly optimistic about his defense business. Bookings suggest operations are well positioned for healthy and steady growth. Its flagship Missiles and Defense product enjoys a healthy order-to-bill ratio of 1.18x. The president’s budget request for 2023 suggests other catalysts for growth in the coming years.

However, there are some risks. There are some valuation risks. The stock has now reached full valuation relative to its own history and is trading at a significant premium to its peers. Its current valuation is around 4 to 5% of its historical average. Such discrepancies could easily be caused by the margin of error in the financial statements and provide no meaningful margin of safety.

The conflict in Ukraine is another major risk. Apart from the lower indications caused by the sanction against Russia, the conflict could also create high-order effects in an unpredictable way and impact RTX. This could aggravate supply shift problems, exacerbate commodity shortages and even trigger a global recession. Given these risks, our final verdict is a hold rating under current conditions.

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