EADSY - RTX downgraded to Equal weight at Morgan Stanley after jet-engine recall

2023-07-26 09:50:16 ET

RTX ( NYSE: RTX ) on Wednesday was downgraded to Equal weight from a previous investment rating of Overweight by analysts at Morgan Stanley. They said the aerospace and defense company has presented investors with “unknown unknowns” after its Pratt & Whitney unit recalled a jet engine because of mechanical defects.

“Investors are concerned that enhanced inspections could find additional potential issues,” Kristine T. Liwag, analyst at Morgan Stanley, said in a July 26 report. “The concern about unknown unknowns is weighing on sentiment as this HPT disc issue was completely unexpected by the market.”

RTX ( RTX ) on Tuesday fell 10% to a nine-month low after disclosing that Pratt & Whitney had found a defect in the high-pressure turbine (HPT) discs of some Geared Turbofan (GTF) engines. A320neo passenger planes made by Airbus ( OTCPK:EADSY ) ( OTCPK:EADSF ) are equipped with the engine. The issue affects some of the engines delivered from the fourth quarter of 2015 through the third quarter of 2021. RTX ( RTX ) management said the HPT discs made today don’t have the defect.

The costs to fix the issue will depend on the number of engines that were already scheduled for maintenance in 2024, and how many will need accelerated service. RTX ( RTX ) didn’t quantify how much it would cost to inspect the 1,000 affected engines in 2024.

“Also, costs depend on the duration of the engine visit as Pratt may be required to make airline customers ‘whole’ depending on specific contract terms,” according to Morgan Stanley. “With a monthly aircraft lease rate of about $300,000 for a new Airbus A320neo, we estimate that 1,000 engines (500 aircraft) in 2024 could result in $150 million in customer compensation per month. Major engine visits are usually three to four months in duration, potentially resulting in customer compensation costs of $450 million-$600 million for the 1,000 engines.”

Morgan Stanley estimated that Pratt & Whitney’s profit margin will narrow to 6% from 6.5% because of the costs associated with inspecting and repairing the affected engines.

The bank also cut its estimate of adjusted EPS for RTX ( RTX ) to $4.95 from $5, and of free cash flow to $4.1 billion from $4.9 billion for 2023. Free cash flow is a closely scrutinized indicator of money remaining after expenses and investments.

“As we de-risk our free cash flow estimates through 2025 and revisit our bull/bear skew to reflect the margin and free-cash-flow risk versus the strong demand environment, we see balanced risk-reward,” according to Morgan Stanley.

The bank lowered its price target on RTX ( RTX ) $95 a share from $110 a share, based on discounting estimated free cash flow per share for 2025 to 2024 and a multiple of 19 times. Morgan Stanley estimated RTX’s ( RTX ) free cash flow will be about $7.8 billion in 2025.

“If the costs are lower than our new forecast and Street’s updated estimates post 2Q23, upward revisions in earnings could create a positive catalyst,” according to Morgan Stanley. “Management indicated that it would have more information on the costs in September 2023.”

The former Raytheon Technologies this month renamed itself as RTX ( RTX ).

Seeking Alpha columnist Manuel Paul Dipold rates RTX ( RTX ) as a Buy, and says the stock's pullback is an occasion to buy more shares . Contributor Leo Nelissen rates RTX ( RTX ) as a Strong Buy, saying the stock's decline is an occasion to back up the truck . Columnist Gary Gambino has a Buy rating on RTX ( RTX ), and says the stock is a bargain as long as the engine problems are contained .

More about RTX

• Airlines could face downtime from RTX engine issue
• RTX plunges to 9-month low after disclosing Pratt & Whitney engine defect
• Safran to buy Collins Aerospace flight control unit in $1.8B deal

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