RTX Stock: Surging OE Offsets Continuing Aftermarket Normalization (NYSE:RTX)

I began covering RTX (NYSE:RTX) (back then still known as Raytheon Technologies) back in November when I assigned an Overweight. My thesis was largely based on the confluence of a heavily discounted valuation in light of the recent GTF issues and a promising portfolio benefitting from the current aerospace upcycle, especially driven by Collins’ aftermarket strength. In January I commented on RTX’s Q4 and FY23 earnings which reaffirming my conviction as the company demonstrated strong execution across all end markets and lack of further bad news on the GTF helped ease investor concerns. Since my initiation shares have performed very strongly, up ~28% versus ~12% gains for both the broader sector and the US market.

With RTX having just released its Q1 24 earnings I continue to see a favorable environment with surging original equipment (“OE”) growth, especially at Pratt, offsetting a beginning normalization of aftermarket. I believe this emerging trend to continue and drive a gradual shift from aftermarket, which had dominated the supply-constrained post-pandemic world, towards OE, very much in line with General Electric’s (GE) investor communication. I remain Overweight on shares and slightly raise my EBITDA-derived price target by 2% to $124 as higher sales growth estimates are offset by OE-driven lower margins, implying ~23% potential upside through YE24.

Key risks remain in a stronger than expected weakening of the global economy affecting the current aerospace upcycle as well as RTX’s commercial aviation business lines failing to offset a normalizing aftermarket through higher OE volumes. Additionally, any delays or other problems regarding the ongoing GTF fleet checks could pose a threat to valuation even though RTX’s execution and communication in the matter has been excellent since the issue first arose publicly.

Earnings Snapshot

For the period ending April 2024 RTX reported headline sales of $19.3B, up 12.2% YoY and $900MM above consensus estimates, driven by significant growth in OE (+33% YoY) vs normalizing aftermarket (+11%). On the bottom line the company recorded a Q1 EPS of $1.34, up 10% vs Q1 23 and 11¢ above street consensus of $1.23 (+9%) for a double-beat. FY24 guidance was also reaffirmed at expected net sales of $78-79B and EPS in range of $5.25-$5.40. Management further continues to forecast ~$5.7B in 24E FCF on capital expenditures of $2.5-2.6B.

Collins Aerospace – Collins’ sales for the trimester came in at $6.7B, up 9% YoY with adj. operating profit climbing 16% to $1,048MM driven by a 90bps margin expansion to 15.7%. OE sales grew 14% YoY, slightly down from Q4’s 17% with aftermarket growth declining to 14% from 23% a Q prior. Defense sales for the segment continued to be roughly flat at 1% annualized growth.

Pratt & Whitney – Pratt recorded a strong acceleration in revenue growth to 23% YoY vs 14% for Q4, driven by a significant surge in OE sales with 64% YoY growth. Similar to Collins, aftermarket sales weakened slightly as YoY growth rate decreased to 9% from 18% as of last Q. Overall segment revenue grew 23% YoY to $6.5B with margins slightly down on higher R&D and SG&A spend to come in at 6.7% on an adjusted basis (operating profit $430MM vs $434MM in Q1 23). I believe Pratt’s Q1 earnings are evident of the reemergence of OE as growth driver across the aerospace sector as capacities become more readily available at the major airframers, enabling significant output growth especially at Airbus (the A320neo series is the biggest end market for the GTF engine). While beneficial to segment topline, this might somewhat negatively affect margins as opposed to aftermarket driven sales. I note that this is not limited to Pratt and its GTF engine but similar developments are projected at GE (see here my note on GE).

Raytheon – Raytheon, which is now RTX’s consolidated defense business formerly consisting of former separate divisions Raytheon Missiles & Defense and Raytheon Intelligence & Space, also recorded an acceleration in topline growth. Sales grew 6% YoY to $6.7B, driven mainly by higher volumes on land and air defense systems including the PATRIOT surface-to-air missile systems and further benefitted by rollout of advanced technology programs. Key business wins during the Q were a ~$1.2 sale of 4 additional PATRIOT systems to the German Bundeswehr and three GEM-T awards worth a combined $1.7B. Classified bookings came in at $1.6B for the period.

Operating margins were roughly flat at 9.5% (up 20bps vs prior year) for $630MM in segment profit as higher volumes and improved productivity was mostly offset by an unfavorable mix. On a QoQ basis margins improved by 50bps and are now 70bps above the recent Q3 23 through as supply chain pressures continue to ease and net productivity levels show early gains from RTX’ corporate-wide efficiency program first announced during the 2023 Investor Day.

Backlog – Consolidated backlog for RTX grew by 12% YoY to reach a record $202B with YoY growth slightly up (20bps) from Q4 23. While defense backlog declined slightly from $78B to $77B (o/w $53B allocated to the Raytheon unit) and growth fell from 13% to ~9% YoY, commercial backlog surged $7B to a record $125B driven by higher OE demand (~15% YoY vs 11% for Q4 23). Consolidated book-to-bill was 1.34 for the Q with Raytheon achieving 1.23. Since Q1 21, total RTX backlog has grown at a CAGR of 11.2% annually or 2.7% per quarter respectively, providing a favorable set up for revenue growth in the near- and mid term.

Valuation

Model Update

On the back of stronger than expected topline growth I raise my projections for 24E and 25E sales growth across all segments. For 24E I now see 10% YoY growth at Collins and 15% at Pratt while Raytheon should come in slightly above flat at 2%. In total I project revenues of $80.8B, ~2% above the $78-79B guided by management. I do note that should Q2 continue to hold up in growth I see a fair chance of a guidance upgrade towards the $80B mark and above.

While sales growth should come in ahead of guidance I slightly downward revise my margin projections as I estimate a further shift from (generally) higher margin aftermarket, towards (generally) lower margin OE. Adjusting for corporate expenses and FAS/CAS pensions I expect $9.8B in consolidated RTX EBIT for 24E, rising to $11.7B by 25E for 12.1% and 13.3% margins. At constant D&A expenses I see EBITDA at $14.4B/$16.6B at respective 17.8% and 19% margins.

Using 25E EBITDA as baseline and continuing to assign RTX’s 3Y-average 13.9x forward multiple, discounted by an unchanged 10% due to the ongoing GTF issues, I see the company’s enterprise value at $208B. Adjusting for ~$37B in net debt and ~$1.7B in minorities yields an equity value of $169B or about $124/sh for ~23% upside potential through YE24.