Financial Pros Pick This Defense Stock

Aerospace and defense stocks go through popularity cycles.

With the U.S. government expanding its defense budget, financial pros began looking at Raytheon Technologies (RTX) more and more.

Search volume increased leading into their earnings last month and remained elevated.

Yet, with free cash flow declining and a premium valuation, we wanted to know if there was an investment here.

Raytheon’s Business

RTX Corporation stands as a luminary in the aerospace and defense industries, delivering cutting-edge technologies for commercial, military, and government sectors. Formed by a strategic merger between Raytheon Company and United Technologies Corporation in 2020, the company is committed to innovation, operational excellence, and social responsibility. What sets RTX apart is its focus on creating long-term shareholder value and its robust commitment to ethical business practices.

With a global footprint, RTX operates private and public clients, playing a vital role in both the commercial aviation and military sectors. 

• Collins Aerospace (34% of total revenues) – Focuses on aviation and space solutions, offering products and services for various aviation-related clients.
• Pratt & Whitney (33% of total revenues) – Engages in the design, manufacturing, and servicing of aircraft engines for commercial, military, and regional aircraft.
• Raytheon (33% of total revenues) – A leader in integrated systems and solutions, specializing in areas like intelligence, missile defense, and cybersecurity.

The Raytheon division can be further segmented into Intelligence & Space and Missiles & Defense.

While Collins is the most profitable individual segment, Raytheon combined accounts for almost half of the company’s total profits.

In the second quarter of 2023, RTX reported impressive figures with sales of $18.3 billion, up 12% from the same period in 2022. 

Adjusted EPS rose 11% to $1.29, a significant growth. However,  operating cash flow was down by 41%, and free cash flow was down by a staggering 72% from 2022. 

The company attributes this to the challenges such as supply chain disruptions and customer insolvencies. Investors and analysts have praised RTX’s resilience and diversification, especially in the face of the current challenges, offering a positive outlook for the future revenue streams.

Financials

Source: Stock Analysis

Raytheon’s put up impressive revenue growth over the last decade.

Note: It merged in 2018 with United Technologies.

However, margins contracted, with gross dropping from +23% to 20%, operating from +10% to ~8%, and free cash flow from ~15% to 4%.

The drop in free cash flow stemmed from a combination of higher inventories and a change in working capital.

If true, it should balance out over time.

However, the company holds a hefty $31.5 billion in net debt, paying over $1.3 billion annually on interest while shelling out over $5 billion in dividends and share buybacks.

If possible, the company would be wise to pay down some of its higher-interest debt.

Valuation

Source: Stock Analysis

Raytheon is one of the more expensive defense companies compared to Lockheed Martin (LMT) or General Dynamics (GD), whether we’re talking about price-to-earnings, price-to-cash flow, or price-to-sales.

It’s even more expensive than Boeing (BA) on a price-to-cash flow basis.

So, does it have growth?

Growth

Source: Seeking Alpha

Kinda.

Raytheon is expected to deliver better revenue growth than LMT or GD. However, BA benefits from a backlog of airplane orders and sales coming off depressed levels.

Virgin Galactic (SPCE) has growth but is far from generating even a dollar of positive cash flow.

Profitability

Source: Seeking Alpha

While RTX has one of the best gross margins, it’s EBIT and net income margins aren’t that great. Neither is its return on capital, assets, or equity.

Our Opinion 6/10

While Raytheon is a great company, it’s simply too expensive at these prices.

The company isn’t generating as much cash as it once did, and doesn’t expect that to change this year.

We’d prefer to wait for the stock to dip by at least a third before considering a position.