RTX - RTX Corporation: P&W Issues Linger Price Action Improves Shares Near Fair Value

2023-12-27 05:52:28 ET

Summary

• Aerospace & Defense stocks have reached all-time highs, with the iShares U.S. Aerospace & Defense ETF up nearly 25% since early October.
• RTX Corporation, a major global Aerospace & Defense company, has been a significant underperformer due to liability risks and operational issues with its P&W segment.
• RTX has seen improvements in its technical situation and has announced a healthy buyback plan, but its operational issues and executive changes remain uncertain.
• I outline key price levels to watch, both on the upside and downside, heading into 2024.

Aerospace & Defense stocks have quietly rallied to fresh all-time highs in recent days. The iShares U.S. Aerospace & Defense ETF ( ITA ) is up close to 25% since its 2023 low notched in early October. Helping the industry over that time has been a sharp bullish reversal in RTX Corporation ( RTX ). The stock had been a major underperformer this year as it battles liability risks in its Pratt & Whitney unit due to a flaw in powder metal used to make some engine parts. The company recorded a $2.9 billion charge in Q3.

I reiterate my hold rating on RTX. I see the fair value price modestly higher today while the technical situation has improved. Still, it's unclear if its operational issues will be over as executive changes take place. A healthy buyback plan is a bullish signal, however.

Aerospace & Defense Stocks Jump to New Highs, RTX Lags in 2023

According to BofA Global Research, RTX Corporation is the combined entity resulting from the merger of equals between Raytheon and United Technologies. RTX is the largest Aerospace & Defense company in the world and has 3 operating units: 1) Pratt & Whitney (military and civil aircraft engines and service operations), 2) Collins Aerospace (interiors, aviation controls, and systems), and 3) Raytheon (previously Raytheon Intelligence & Space and Raytheon Missiles & Defense).

The Virginia-based $119 billion market cap Aerospace & Defense industry company within the Industrials sector trades at a modest 16.6 forward 12-month non-GAAP price-to-earnings ratio and pays an above-market 2.8% dividend yield. Ahead of earnings next month, shares have a low implied volatility percentage of 20%, and short interest on the stock has shot up to 5.8%.

Back in October, RTX reported non-GAAP EPS of $1.25 , topping the consensus estimate of $1.22 while adjusted revenue came in at $19 billion, a 12% increase from year-ago levels, also beating expectations. Profit growth was strong even though concerns continued regarding a $5.4 billion hit to sales for Pratt & Whitney's powder metal issue (a $2.9 billion negative impact on operating profit). Its top-performing segment for the quarter was Collins Aerospace - it featured a 16% YoY revenue jump.

Helping to buoy the stock, the management team raised its 2023 sales outlook to $74 billion and it updated its adjusted EPS outlook to be in the $4.98 to $5.02 range while free cash flow is forecast to be $4.8 billion for the year. Another positive sign? RTX approved a $10 billion stock buyback plan , and it looks to repurchase up to $12.8 billion in stock this year alone. The sale of its Cybersecurity, Intelligence, and Services unit, a $1.3 billion influx, should support the buyback effort.

RTX: Shareholder Accretive Activities

RTX has landed a few contracts amid executive changes , and the company may be turning the corner. I would like to see further signs that the Pratt & Whitney challenges are in the rearview mirror.

On valuation , analysts at BofA see earnings rising by less than 5% this year while per-share profits are expected to increase by just 4% in 2024. The sellside consensus forecast is more upbeat when looking at the out years, though, as Seeking Alpha's latest numbers show a 17% EPS growth rate by 2025 while sales growth is robust in the mid to high single digits over the coming years.

Dividends, meanwhile, are expected to rise at a steady clip over the coming quarters. With an operating earnings multiple that is now in the mid-teens, the value case is compelling, though its EV/EBITDA multiple is merely at the S&P 500's average. Still, free cash flow is steady, near a 3.8% FCF yield today.

RTX: Earnings, Valuation, Dividend Yield, Free Cash Flow Forecasts

If we assume a 16x forward non-GAAP P/E, below its 5-year average and under the market's median given ongoing idiosyncratic fundamental issues, and forward operating EPS of $5.40, then shares should be near $86. That is a slight increase from my previous valuation given a solid Q3 earnings beat, buyback announcement, and slightly lower interest rates.

Thus, the valuation picture appears mildly more attractive today for this aerospace stock, and I even see some upside potential to the multiple if the P&W issues recede. I am encouraged to see about an even mix of sellside analyst EPS upgrades and downgrades - I feared a slew of earnings downgrades following the September update to its Pratt & Whitney GTF fleet and lowered sales outlook.

RTX: Mixed Valuation Metrics, Upside Risk to the Multiple Pending P&W Issues

Compared to its peers , RTX features a middle-of-the-road valuation grade, though growth is particularly soft compared to the competition. Still, the firm has maintained strong profitability trends and reliable free cash flow over recent years, and I expect those trends to persist as the macro landscape turns more positive amid ongoing geopolitical conflicts.

Still, RTX's share-price momentum has been quite soft throughout 2023, though I will highlight why the technical situation has improved following the late-Q3/early-Q4 washout. And, once again, the EPS revisions trend could have been much worse.

Competitor Analysis

Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q4 2023 earnings date of Tuesday, January 23 BMO. No other volatility catalysts are seen on the calendar.

Corporate Event Risk Calendar

The Technical Take

A lot has transpired since I last reviewed RTX Corp earlier this year. Notice in the chart below that shares indeed endured a bearish breakdown below the key $79 to $80 area. A major flush lower to under $70 took place in September and early October on high volume during that stretch. The bulls recovered, though, and managed to send the stock back above the critical technical level. Today, with RTX in the low $80s, it is not far from my intrinsic value fundamental level as a potentially bullish false breakdown is now in play.

The coast is not all clear, however. Take a look at the long-term 200-day moving average - it's currently at $88 and falling. A 200dma trending down indicates that the bears have a grip on the stock. What is encouraging is that price is consolidating after a strong rally from early October through early November while the RSI momentum oscillator works off technical overbought conditions. Meanwhile, an upside gap looms near $96 - that is a potential target should the bulls take RTX higher again. I would avoid the stock should it break back below the upper $70s support point. Finally, gains could be tough given a high amount of volume by price from the low $80s up to near $100 - that's a hefty amount of supply that may look to sell to get back to even.

Overall, RTX appears better technically given a move back above $80. $96 could be in play, but there are several headwinds facing the bulls here.

RTX: Bearish Overhead Supply, Stock Under the 200dma, Holding Key $79-$80 Range

The Bottom Line

I reiterate my hold rating on RTX. The firm still faces fundamental concerns while the technical picture remains mixed.

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