RTX - RTX Corporation: The Best Defense Stock To Buy Now

2023-10-17 14:45:56 ET

Summary

• Demand for defense stocks has dropped, causing a substantial decline in RTX Corporation, aka Raytheon, shares.
• Despite the recent rebound, Raytheon stock remains cheap, with potential for double-digit EPS growth and healthy revenue growth in future years.
• Raytheon produces innovative and in-demand products, making it a top defense pick with growth opportunities.
• Raytheon's stock should go considerably higher in the coming years.

I've long had a defense segment in my portfolio. I expanded my defense holdings as the Ukraine/Russia war broke out. However, after an initial strong showing, their momentum died down. Demand for defense stocks died down, the upside potential appeared minimal, and I sold most of my defense holdings in Q3 (August this year).

I wasn't alone in selling defense stocks, as the whole market seemingly lost interest in the space. iShares U.S. Aerospace & Defense ETF ( ITA ) dropped by around 15% from its high in August to its recent low in October, just before the conflict in the Middle East erupted.

1-Year Chart ITA

By the time the October bottom happened, many high-quality defense contractors had become highly oversold technically and undervalued from a fundamental perspective. ITA's RSI crashed below 30, illustrating more significant oversold conditions than the bear market bottom in October 2022.

ITA's most significant holding, my favorite defense stock, RTX Corporation ( RTX ), also known as Raytheon, dropped by approximately 35% from its high in 2023. Moreover, despite Raytheon's post-Israel/Hamas conflict rebound, its stock remains remarkably cheap.

Raytheon - Exceptionally Cheap

Raytheon trades at only around 13 times 2024 Consensus EPS estimates and 11 times 2025's expectations. This dynamic suggests that Raytheon should provide double-digit EPS growth in the coming years. Additionally, EPS estimates could be revised as demand for Raytheon's products increases. Moreover, Raytheon consistently surpasses EPS estimates, outpacing consensus expectations in each of the twenty quarters in the last five years.

Raytheon - Likely To Beat EPS Estimates

Despite a challenging macroeconomic environment, Raytheon beat its TTM EPS estimates by 29 cents (8.4%). 2024's consensus estimates are for $5.58. If Raytheon puts up a similar beat rate, it could earn $6.05 in 2024. Raytheon's stock is around $74 now, implying its forward P/E ratio is about 12. Also, Raytheon's consensus figures suggest its EPS could be $6.56 in 2025, but a similar 8% beat rate would put its EPS toward the higher end of analysts' estimates, roughly $7.11. This earnings growth dynamic suggests Raytheon should provide solid double-digit EPS growth in future years and only trade at 10.4 times 2025's anticipated earnings. Additionally, Raytheon pays a very healthy, growing 3.22% dividend.

Why Raytheon Is My Number One Defense Pick

Aside from providing an excellent dividend, being exceptionally cheap, offering growth possibilities, and having a high probability of surpassing estimates, Raytheon produces some of the most innovative and in-demand products in the defense industry. Moreover, Raytheon's weapons could experience increasing demand as conflicts in Ukraine, the Middle East, and other areas continue. Raytheon operates through four primary segments.

The "Raytheon" Segments

While Raytheon Intelligence & Space and Raytheon Missiles & Defense are considered two separate segments, I will discuss them as one for the sake of simplicity.

Raytheon, a top aerospace and defense contractor, provides some of the most innovative systems and services globally for commercial, military, and government customers. Raytheon provides the U.S. and its allies with the necessary firepower to dominate the air and "own the skies."

Raytheon produces state-of-the-art market-leading air-to-air AMRAAM missiles and the Aim 9X, the most advanced infrared-tracking, short-range, air-to-air, and surface-to-air missiles worldwide. Raytheon also equips next-generation aircraft with advanced air-to-surface precision weapons systems. Raytheon offers advanced surveillance equipment, like the Global Hawk, and much more.

Raytheon is also a global leader in hypersonic weapons technologies, innovating and leading the industry in Mach 5 offensive and defensive systems that should provide growth opportunities in the new age. Raytheon also produces the highly popular and effective Tomahawk cruise missile .

Furthermore, Raytheon manufactures Global Patriot Solutions , a comprehensive missile defense system designed to detect, identify, and defeat tactical ballistic missiles, cruise missiles, drones, advanced aircraft, and other threats. Currently, the Patriot System is the foundation of the air and missile defense for 18 nations.

Collins Aerospace Segment

Raytheon also services various industries through its Collins Aerospace Segment. Industries Raytheon services include airports, business aviation, commercial aviation, helicopters, military and defense, and space. The segment's most notable capabilities include autonomous operations, cabin experience, connected battle space, connected ecosystem, electrified aircraft, structural technologies, and more.

The Pratt & Whitney Segment

I spent much of my life in Connecticut, so I know the Pratt & Whitney enterprise. It's headquartered in a neighboring town where I grew up. Also, my brother spent many years working at a competing specialized aerospace and defense part manufacturer, Birken Manufacturing , in CT. Pratt & Whitney is a significant segment and is one of the "big three" aero engine manufacturers globally.

It has 16,000 customers using its engines in more than 200 countries and territories, with over 85,000 engines in service globally. The company also has around 41,000 employees in over 40 countries, with $20.5B in sales in 2022. The segment also posted $1.3 billion in adjusted operating profits last year.

Raytheon Vs. Other Top Defense Contractors

• Raytheon: Forward P/E ratio (consensus 2024) - 13, EPS growth - 11%, Revenue growth - 9%, forward PEG ratio - 1.18, Dividend - 3.2%.
• Lockheed Martin ( LMT ): Forward P/E ratio (consensus 2024) - 16, EPS growth - 3%, Revenue growth - 3%, forward PEG ratio - 5.33, Dividend - 2.8%.
• Northrop Grumman ( NOC ): Forward P/E ratio (consensus 2024) - 20, EPS growth - 9%, Revenue growth - 6%, forward PEG ratio - 2.22, Dividend - 1.5%.
• General Dynamics ( GD ): Forward P/E ratio (consensus 2024) - 17, EPS growth - 17%, Revenue growth - 6%, forward PEG ratio - 1, Dividend - 2.2%.

The Takeaway

Raytheon is significantly cheaper than other top defense contractors. While General Dynamics has a lower PEG ratio, its earnings growth seems less stable than Raytheon's, and the PEG ratio is skewed due to the minimal 3% EPS growth this year. Also, Raytheon pays a more significant dividend than its competitors, offering the best revenue growth and the most EPS growth potential. Therefore, Raytheon is the best buy amongst defense companies here.

What Wall St. Thinks

Wall Street has a buy rating on Raytheon stock, with an average price target of around $90, roughly 20% above its current price. Moreover, the lower-end target range is $70, implying minimal downside. Furthermore, higher-end price targets go up to about $111, suggesting that Raytheon's stock could appreciate by around 50% over the next year in a bullish case scenario.

Where RTX's stock price could be in future years:

Source: The Financial Prophet

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