RTX - RTX Corporation's Underrated Stock: A Haven Amid Middle East Crisis

2023-10-19 10:29:21 ET

Summary

• RTX Corporation is one of the largest aerospace and defense companies, with a diverse portfolio of systems and services in high demand by military and commercial customers worldwide.
• On October 24, RTX will publish its financial report for the 3rd quarter of 2023.
• Meanwhile, given the war in the Middle East, we believe that Raytheon Missiles & Defense will greatly contribute to improving RTX's financial position.
• Growing geopolitical tensions in the world, especially in the Middle East and Eastern Europe, contribute to maintaining interest in the company from Wall Street mastodons.
• We initiate our coverage of RTX Corporation with an "outperform" rating for the next 12 months.

RTX Corporation ( RTX ) is one of the largest aerospace and defense companies headquartered in Arlington, with a diverse portfolio of systems and services in high demand by military and commercial customers worldwide.

We emphasize three of the company's four segments, accounting for 84.9% of its total revenue. The first is Collins Aerospace, a global supplier of products to the aerospace and defense (A&D) industry, including aircraft maintenance services for airlines and airplane manufacturers.

Collins' portfolio consists of numerous products, including engine control systems, navigation systems, aviation systems, and flight control systems used on multiple Boeing ( BA ) and Airbus (EADSY) aircraft. Moreover, this division is supplying power generation systems as part of a contract with Boeing to modernize the B-52, a long-range strategic bomber.

The second segment, which contributed about 31.1% of RTX's total revenue for Q2 2023, is Pratt & Whitney. The end of the acute stage of COVID-19 helps maintain growing demand for the company's aircraft engines used in wide-body and narrow-body aircraft. Its key customers have long been Airbus, Embraer ( ERJ ), and General Dynamics ( GD ). Also, due to the advantages of its PW800 engine, it was chosen exclusively for several Gulfstream and Dassault Aviation business jets.

In addition to civil aviation, Pratt & Whitney supplies F135 engines for various variants of Lockheed Martin's F-35 ( LMT ). Given Iran's rhetoric and geopolitical tensions in the South China Sea, we believe that demand for these aircraft from NATO members will remain high.

Meanwhile, given the war in the Middle East, we believe that Raytheon Missiles & Defense will greatly contribute to improving RTX's financial position. This segment is a supplier of products aimed at detecting and countering various threats. We expect that due to increasing geopolitical tensions in the world, demand for the NASAMS and Patriot missile defense system, the company's air-to-air and air-to-ground missiles, will continue to grow. The company does not rest on its progress and is developing next-generation systems and technologies , including counter-hypersonics and radars, which will strengthen US leadership in the arms industry.

Growing geopolitical tensions in the world, especially in the Middle East and Eastern Europe, contribute to maintaining interest in the company from Wall Street mastodons. The top five shareholders of RTX Corporation, collectively owning 31.9% of the company, include Vanguard Group, Blackrock, Capital International Investors, State Street, and Capital Research Global Investors.

The second quarter of 2023 showed remarkable results, as not only RTX's revenue was able to exceed analysts' expectations, but also the company's management business strategies aimed at stabilizing its gross margins continue to remain effective despite persistent inflationary pressures. Moreover, its EPS continues to beat analysts' consensus estimates in recent years, indicating Wall Street is conservatively assessing the company's business prospects despite rising geopolitical tensions worldwide.

On October 24 , RTX will publish its financial report for the 3rd quarter of 2023. According to data from Seeking Alpha , RTX Corporation's third-quarter 2023 revenue is expected to be $13.32 billion to $19.13 billion, up 8.6% year-over-year and 28.2% higher than analysts' expectations for the prior quarter. At the same time, following our model, the company's total revenue will be slightly above the median of this range and will amount to $18.4 billion.

RTX's revenue growth will be driven by increased sales of Raytheon Missiles & Defense and Pratt & Whitney products to commercial and military customers and boosted demand for aircraft maintenance due to increased airline travel volumes in the post-COVID-19 era. These factors, in particular, will mitigate the negative impact of the strengthening US dollar against the euro in our view.

We forecast that RTX's operating income margin will reach 11.1% by 2023. Moreover, in 2024, this financial metric will increase to 11.6%, thanks to an increase in the number of new orders from Israel and NATO members, optimization of labor costs, and reduction in the price of raw materials used for the production of aircraft engines, missiles, and various systems.

According to Seeking Alpha data, RTX Corporation's Q3 EPS is expected to be $1.13-$1.3, up 3.4% from the consensus estimate for Q2 2023. At the same time, according to our model, RTX's EPS will be in this range and reach $1.25.

Moreover, the company's Non-GAAP P/E [TTM] is 14.68x, which is 10.64% lower than the sector average and 21.38% lower than the average over the past five years. Additionally, RTX's Non-GAAP P/E [FWD] is 14.85x, which is one of the many factors indicating its undervaluation by Mr. Market during the period of growth in passenger aircraft production, largely due to the recovery of passenger traffic in the world.

According to the Transportation Security Administration , the total number of passengers was 37.37 million in the first fifteen days of October 2023, an increase of 11.2% from the previous year.

Like numerous other aerospace and defense companies, RTX's debt has continued to rise in recent quarters, putting pressure on its net income margin. At the end of the second quarter of 2023, RTX's total debt was about $36.9 billion, an increase of $3.37 billion over 2021. On the other hand, the company's EBITDA continues to grow yearly, resulting in its total debt/EBITDA ratio remaining around 3x.

Conclusion

RTX Corporation is one of the largest aerospace and defense companies headquartered in Arlington, with a diverse portfolio of systems and services in high demand by military and commercial customers worldwide.

Due to issues discovered in the production of components using contaminated metal powder, Pratt & Whitney had to remove over 600 of its geared turbofan ((GTF)) engines from aircraft for quality checks, according to news from September 2023 . As a result of these challenges, the company's share price has experienced a decline of over 26% since the beginning of the year.

Despite all the difficulties that RTX has encountered in recent months, its management continues to increase dividend payments yearly. Moreover, given the company's rising revenue, its dividend yield of 3.19%, and the growing geopolitical tensions in the Middle East due to aggressive actions by Hezbollah and Hamas against Israel, we initiate our coverage of RTX with an "outperform" rating for the next 12 months.

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