Raytheon Technologies – Fairly Valued – Introduction
With Raytheon Technologies having a defence business that serves domestic and international military and government customers, some investors may automatically rule it out as a potential investment. We, however, need to put things in perspective.
History is rife with examples of country heads who exhibit toxic traits and routinely engage in dysfunctional behaviour. They typically dream up conspiracy theories, crush opponents through force and/or falsehoods, and actively incite fear and hatred for selfish purposes. These country heads become increasingly delusional to the point where other countries need to ensure they can defend themselves from countries that develop their own weapons.
Regrettably, the world might be even more destabilized than at present if companies such as:
- Raytheon Technologies (RTX)
- Lockheed Martin (LMT)
- Northrop Grumman (NOC)
- General Dynamics (GD)
- L3Harris Technologies (LHX) and
- Huntington Ingalls (HII)
were not engaged in the business of manufacturing weapons.
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Who Is Swimming Naked?
With global monetary policies that create disincentives for ‘savers’, many people have become increasingly concerned about a ‘silent crisis of retirement’. Presently, a huge segment of the population is beginning to put money to work in the stock market instead of keeping it in lower-risk investments or savings accounts.
In addition, we have:
- a new pool of investors who have identified the stock market as a form of gambling/entertainment;
- a pandemic which has forced people to spend more time at home in front of their computer;
- new trading platforms that encourage frequent trading;
- investors with little/no concept of the degree of risk being assumed;
- a low-interest-rate environment that has helped propel margin debt to unprecedented levels.
All these factors, and more, contribute to a stock’s price becoming detached from the underlying fundamentals of the business.
There is no disputing some investors have become extremely lucky despite having no concept of what they are doing. As Warren Buffett (Chairman of Berkshire Hathaway), however, so famously states:
‘Only when the tide goes out do you discover who has been swimming naked.’
The ‘good times’ do not remain ‘good’ in perpetuity. ‘Stuff’ happens unexpectedly and at the least opportune time. Investors would, therefore, be wise to heed Buffett’s advice:
‘Rule #1: Never Lose Money. Rule #2: Never Forget Rule Number One.’
‘Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.’
Keeping these rules in mind, investors would be wise to invest in high-quality companies when reasonably valued.
This brings us to RTX.
Raytheon Technologies – Fairly Valued – Business Overview
RTX operates in an industry characterized by:
- customer-paid R&D;
- regulated margins;
- mature markets; and
- long-term revenue visibility.
We can learn about a company by reading the Business and Risk Factors sections in the most recent 10-K. In RTX’s FY2020 10-K, there is a comprehensive overview of the 4 principal business segments:
- Collins Aerospace Systems;
- Pratt & Whitney;
- Raytheon Intelligence & Space; and
- Raytheon Missiles & Defense.
Another great source of information is the company’s website. This link takes you to each business segment’s site where we find a good overview of that segment’s unique capabilities.
I also highly encourage you to review RTX’s 2021 Investor Day presentation presented on May 18, 2021.
You may also be interested in reading posts I have recently written about:
- Lockheed Martin (LMT),
- Northrop Grumman (NOC), and
- Heico (HEI.a and HEI)
They compete with RTX and yet also work jointly with it on various projects. These posts are found at Financial Freedom is a Journey.
Raytheon Technologies‘ Transformation
On April 3, 2020, United Technologies Corporation completed the acquisition of Raytheon Company. The company was then renamed Raytheon Technologies Corporation. In conjunction with this acquisition was United Technologies’ tax-free spin-off of Otis Worldwide Corp (OTIS) and Carrier Global Corp. (CARR). Both OTIS and CARR started trading as separate public entities on April 3, 2020.
Even before the spin-offs and the merger with Raytheon Company, the following significant events occurred.
- November 2015 – United Technologies sold Sikorsky to Lockheed Martin (LMT); and
- November 2018 – United Technologies completed the acquisition of Rockwell Collins.
In my opinion, comparing RTX’s current performance and prospects against historical results is almost pointless. This is because RTX has undergone such a significant transformation.
Lockheed Martin’s Impending Acquisition of Aerojet Rocketdyne
On December 20, 2020, Lockheed Martin (LMT) agreed to acquire Aerojet Rocketdyne Holdings, Inc. for a transaction value of ~$4.4B after the assumption of Aerojet Rocketdyne’s projected net cash. The rationale for this acquisition is to enhance LMT’s and the industry’s ability to meet future national security and civil space objectives when it comes to propulsion.
RTX has raised objections to this acquisition in that it is a major Aerojet Rocketdyne customer for rocket motors.
Further details on this matter are covered in my Lockheed Martin Stock Analysis.
Raytheon Technologies – Fairly Valued – Financial Review
Q2 and YTD Results
On July 27, 2021, RTX released Q2 and YTD results and also increased guidance for the remainder of FY2021.
A list of notable defence bookings in Q2 and highlights within each of RTX’s 4 principal business segments are found in the Q2 Earnings Release.
On the ‘significant awards’ front, RTX received in Q2 the following:
- over $1B in classified bookings at Raytheon Intelligence & Space;
- two important franchise wins in RTX’s Missiles & Defense business (~$2B for the Long-Range Standoff weapon and $1.3 billion for the Next-Generation Interceptor).
RTX’s Patriot franchise remains robust as evidenced by Switzerland becoming the 18th partner nation to select the Patriot air defence system.
On the commercial air traffic front, demand continues to gain momentum across many domestic markets as global economies reopen and vaccinations increase. The COVID variants and the resurgence in COVID cases, however, means that RTX is closely monitoring the impact on travel.
Free Cash Flow (FCF)
FCF is a metric I closely monitor. It allows me to gauge the degree of efficiency in which a company generates cash for reinvestment, dividend, or share buyback purposes.
RTX has generated $1.302B in YTD FCF.
- In Q1, RTX generated Operating Cash Flow (OCF) from continuing operations of $0.723B. Capital expenditures were $0.387B resulting in FCF of $0.336B.
- In Q2, RTX generated Operating Cash Flow (OCF) from continuing operations of $1.326B. Capital expenditures were $0.36B resulting in FCF of $0.966B.
RTX has turned in solid Q2 and YTD2021 results. We should, however, evaluate an investment based on a company’s outlook and long-term prospects.
At RTX’s May 18, 2021 Investor Meeting, senior management highlighted how the company is well-positioned for growth and laid out its 2025 goals to deliver strong top-line growth, margin expansion and at least $10B in FCF by 2025, while continuing to invest in the 4 principal business segments and returning significant cash to shareholders.
We see that RTX stands to benefit from the requested FY2022 US Department of Defense modernization budget. Furthermore, commercial air traffic has begun to recover and further recovery is anticipated.
On the Q2 earnings call, management stated it is witnessing encouraging trends across its market. Much like LMT, RTX stands to benefit from the US Department of Defense’s FY2022 budget request. This budget request was generally in line with RTX’s expectations concerning its portfolio of products and the investments it is making in differentiated technologies, including missile defence, space-based systems, next-generation propulsion and hypersonics.
In addition, major RTX programs stand to benefit as overall modernization funding remains at near historic highs; requested funding for these programs is favourable to the overall Department of Defense modernization request when compared to FY2020’s plan for FY2022. Furthermore, the overall classified funding request which supports a significant part of RTX’s Intelligence & Space portfolio was also very well supported in the recent FY2022 budget request.
In Q2, RTX’s order backlog rose to a record $151.8B; $85.7B of this order backlog was from commercial aerospace and $66.1B was from defence. This represents a 3% increase from Q1 and explains the rationale for various metrics having been revised upwards.
As it relates to merger integration activities, RTX’s substantial progress on this front and its pipeline of opportunities have led management to raise the gross cost synergy target by another $0.2B to $1.5B. This $1.5B will be realized in the first 4 years following the Raytheon/United Technologies merger. This new level is now 50% more than the original synergy commitment.
Raytheon Technologies – Fairly Valued – Credit Ratings
We each have our respective tolerance for risk. What I have witnessed over the years, however, is that one’s tolerance for risk can suddenly change depending on circumstances. Therein lies the problem. By the time one suddenly determines a need to ‘dial back’ risk….it is sometimes too late.
My personal observation is that many new investors think investing consists merely of monitoring stock chart patterns and a long-term investment time horizon is now a matter of days or weeks versus several years/decades. Investing in high-quality companies for the long-term now appears to be as outdated.
These same investors often have little knowledge about the companies in which they invest. As a result, they have little clue about the risk aspect of their investments.
We also have investors lured by SPACS and the modern-day version of the Dutch Tulip Bulb (ie. cryptocurrencies). In addition, many investors gravitate toward high yield securities with little realization that a good portion of the yield includes a return of capital.
When I retired early several years ago I vowed never to position myself to incur a permanent major impairment to my capital. I, therefore, pay particularly close attention to the degree of risk I am assuming when I invest in a company. In this regard, I look at a company’s domestic unsecured long-term debt ratings and the outlook assigned to these ratings by the major rating agencies.
RTX’s current domestic unsecured long-term debt ratings and outlook are:
- Moodys’ – Baa1 (stable) – this is the top tier of the lower-medium grade investment grade category.
- S&P Global – A- (negative) – this is the bottom tier of the upper-medium grade investment grade category.
S&P Global’s rating is one notch higher than the rating assigned by Moody’s.
Moody’s defines RTX as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity for RTX to meet its financial commitments.
S&P Global defines RTX as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than entities in higher-rated categories.
As equity investors, we must be fully aware our risk is greater than that of unsecured long-term debt holders. This is readily apparent when we see the ease with which companies in financial difficulty cut/eliminate their dividend. Reducing/suspending debt-related payments has far greater ramifications than a dividend cut/elimination.
RTX’s investment-grade ratings meet my risk tolerance.
Raytheon Technologies – Fairly Valued – Dividends and Share Repurchases
Dividends and Dividend Yield
RTX is a relatively new publicly-traded company so the dividend history only dates back to early 2020. However, the stock is considered a Dividend Aristocrat since it inherited the dividend history of United Technologies, one of the predecessor companies.
The stock information section of the company’s website includes the historical dividends for United Technologies Corporation and Raytheon Company. I view this information to be of limited value and to be more for interest purposes.
RTX is scheduled to distribute its 2nd quarterly $0.51 dividend on September 9, 2021 to shareholders of record on August 20; shares go ex-dividend on August 19.
The ex-dividend date for stocks is usually set one business day before the record date. To receive the next dividend, you must purchase before the ex-dividend date. If you purchase a stock on its ex-dividend date or after, the seller gets the dividend.
With RTX currently trading at ~$88, the dividend yield is ~2.3%. I caution my fellow Canadian investors to be aware the dividend yield is currently just under 2% if RTX shares are held in a taxable account; there is a 15% withholding tax.
The dividend yield may be unacceptable to some investors because their investment priority is to generate dividend income.
I can easily think of many companies with lofty dividends yields whose long-term overall investment return is far inferior to that of companies that distribute no dividend or whose dividend yield is razor-thin. I think it is short-sighted to fixate on dividend yield or the number of consecutive years of dividend increases. Investors should focus on an investment’s potential overall return.
On December 7, 2020, RTX’s Board of Directors authorized a share repurchase program for up to $5B of common stock; this replaced the previous program announced on October 14, 2015.
On December 31, 2020, the maximum dollar value of shares that were available for purchase under this program was $5B; RTX did not make any share repurchases during the quarter ended December 31, 2020. Furthermore, no shares were reacquired in transactions outside the program during the quarter ended December 31, 2020.
Despite share repurchases of $0.375B and $0.632B in Q1 and Q2 2021, RTX’s diluted weighted average number of shares outstanding (in millions) has risen from 1,358.7 as of FYE2020 (December 31, 2020) to 1,513.7 as of June 30, 2021. This increase is largely attributed to the issuance of shares under the terms and conditions of RTX’s 2018 Long-Term Incentive Plan that was revised in February 2021. A comprehensive explanation of this plan is found in RTX’s Q1 10-Q commencing on page 84 of 119.
On the Q2 earnings call, management reiterated its commitment to repurchase at least $2B of shares in FY2021.
Raytheon Technologies – Fairly Valued – Current Valuation
Some investors try to determine a company’s current valuation using their projections of a company’s earnings several years into the future and their estimates for other input data for these mathematical models. The mathematical models used to derive a company’s valuation looks impressive. The results, however, are highly susceptible to change depending on the input data.
I have never quite been able to determine how a company is going to perform 10 years into the future, let alone 4 – 5 years. Given this, I am very reluctant to use estimated earnings beyond the next couple of fiscal years.
On this basis, let’s try to gauge RTX’s current valuation based on management’s FY2021 adjusted diluted EPS estimates and FY2021 – FY2023 estimates from brokers which cover RTX.
RTX shares currently trade at ~$88 and management’s FY2021 adjusted diluted EPS guidance has been revised upwards to $3.85 – $4. Using this information, we get a forward-adjusted diluted PE range of ~22 – ~23.
Although some brokers are likely in the process of adjusting their projected adjusted diluted EPS estimates following the July 27 release of Q2 results, the following valuation data is based on guidance currently available from the trading platforms of the 2 discount brokerage firms I use.
- FY2021: 23 brokers, mean estimate $3.98, low/high range $3.68 – $4.35. Valuation using mean estimate is ~22 and ~20 using high end of range.
- FY2022: 23 brokers, mean estimate $4.99, low/high range $4.30 – $5.70. Valuation using mean estimate is ~17.6 and ~15.43 using high end of range.
- FY2023: 17 brokers, mean estimate $6.09, low/high range $5.44 – $6.89. Valuation using mean estimate is ~14.4 and ~12.78 using high end of range.
Naturally, the value of a dollar in 2023 is less than the value of a dollar in 2021. In addition, the degree of uncertainty of estimated earnings further out on the calendar increases and we also see a wide range in earnings estimates.
Given the above, I view RTX as fairly valued with a current forward adjusted diluted PE in the ~16 – ~18 range.
In contrast, I view LMT’s current valuation to be in the low teens (see my July 26th post).
Raytheon Technologies – Fairly Valued – Final Thoughts
I initiated a position on April 18, 2008, when the company was formerly United Technologies (UTX). I have subsequently added to my position several times over the years including the following most recent purchases:
- 300 shares on October 22, 2018 through a ‘Side’ account within the FFJ Portfolio
- shares on June 11 2019 through a retirement account for which I do not disclose details
- 100 shares on October 11 2019 through a ‘Side’ account within the FFJ Portfolio
- shares on March 5 2020 through a retirement account for which I do not disclose details
- shares on September 22 2020 through a retirement account for which I do not disclose details
- 300 shares on October 1 2020 through a ‘Core’ account within the FFJ Portfolio
Following the acquisitions and divestitures reflected earlier in this post, RTX ended up as my 24th largest holding when I last analyzed all my holdings (April 12, 2021) in accounts for which I disclose and do not disclose details.
My RTX investment has not performed as well as I had anticipated and I think the reason for this is that it was not a ‘focused’ business. Following a series of acquisitions and divestitures, however, RTX is now much more focused and I expect its performance to improve.
We also see that the business and operations and the industries in which RTX operates (ie. commercial, business jet and general aviation) are slowly recovering from the devastating impact of COVID-19 (eg. travel restrictions).
As much as I think RTX is currently fairly valued and will reward shareholders over the long term, it is not my intent to acquire additional shares. I am satisfied with my current exposure but fully intend to increase my exposure to the aerospace and defence industry.
I thought about increasing my exposure to this industry by initiating a position in Northrop Grumman as per my June 21, 2021 post. Upon further reflection, however, I plan to increase my exposure in HEI.a and LMT; I disclose my rationale for acquiring additional HEI.a shares in this June 12, 2021 post and additional LMT shares in these July 14, 2021 and July 26, 2021 posts.
I prefer LMT over RTX for reasons that include, but are not limited to, its superior valuation and higher credit ratings.
HEI.a is definitely not trading at a valuation similar to LMT and RTX. Furthermore, it is a much smaller company than RTX and LMT. It appeals to me, however, as per my reasoning in my June 12, 2021 post.
In my opinion, a portfolio that includes exposure to RTX, LMT and HEI.a sets up an investor for a very reasonable probability of generating attractive long-term investment returns.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom.
Thanks for reading Raytheon Technologies (RTX) – Fairly Valued!
Disclosure: I am long RTX, LMT, and HEI.a.
Author Bio: I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 33 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.
Author Disclosure: I disclose holdings held in the FFJ Portfolio and the dividend income generated from these holdings. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.
Author Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.
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I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 34 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.