With Raytheon Technologies (RTX -0.35%) having released its first-quarter earnings report, it's become clear the recovery in the commercial aerospace market has been a bit slower than many anticipated going into the quarter. That said, it's important not to get mired in quibbling over the pace of a long-term recovery when it's in its early stages. Recovery is coming, and it's a case of "when, not if" commercial air travel comes back. In this context, Raytheon's recent earnings help highlight why the stock is an excellent buy for long-term investors. Here's why.
Some weakness in the first quarter
The case for buying Raytheon Technologies stock rests on the idea that its defense businesses will support the company through a difficult period. At the same time, the commercial aerospace-focused businesses will embark on a multi-year recovery from a trough in 2020.
It's not an exact split, but its defense operations are overwhelmingly in the former Raytheon Company businesses, Raytheon Missiles & Defense (RMD) and Raytheon Intelligence & Space (RIS). Meanwhile, the commercial aerospace businesses are in the former United Technologies business, Collins Aerospace and Pratt & Whitney.
Image source: Getty Images.
Unfortunately, conditions in the first quarter could have been better. During the earnings call, CFO Neil Mitchill noted that international air travel is "a little slower than we thought" and CEO Greg Hayes outlined that the widebody aftermarket "is not recovering nearly as fast as what we thought it was going to."
That said, there's plenty of other evidence to suggest that Raytheon remains on a sound track to begin a multi-year recovery in 2021. I have three points.
Management upgraded guidance
Despite the slightly disappointing performance in the first quarter within commercial aerospace, management was so impressed with the momentum at the end of the first quarter and in the second quarter so far that it raised full-year guidance. It wasn't a highly significant hike in guidance, with only the low ends of the ranges for sales and earnings being increased.
However, the key point is that the hike in guidance came even after a slightly disappointing first quarter from an end-market perspective.
| Raytheon Technologies |
Current Guidance |
Previous Guidance |
|---|---|---|
|
Sales |
$63.9 billion to $65.4 billion |
$63.4 billion to $65.4 billion |
|
Organic sales growth |
Flat to 3% |
1% to 3% |
|
Adjusted EPS |
$3.50 to $3.70 |
$3.40 to $3.70 |
|
Free cash flow |
$4.5 billion |
$4.5 billion |
Data source: Raytheon Technologies presentations.
Also, the increase in guidance comes down to commercial aerospace-focused businesses. That's a good sign for the rest of 2021.
| Raytheon Technologies Business |
Current Guidance Adjusted Sales Growth |
Previous Guidance Adjusted Sales Growth |
Current Guidance Adjusted Operating Profit Increase |
Previous Guidance Adjusted Operating Profit Increase |
|---|---|---|---|---|
|
Collins Aerospace Systems |
down MSD to down LSD |
down HSD to down LSD |
down $200 million to up $25 million |
down $275 million to up $25 million |
|
Pratt & Whitney |
up LSD to up MSD |
flat to up MSD |
down $75 million to $25 million |
down $125 million to up $25 million |
|
Raytheon Intelligence & Space |
up LSD to up MSD |
up LSD to up MSD |
up $125 million to $175 million |
up $125 million to $175 million |
|
Raytheon Missiles & Defense |
up LSD to up MSD |
up LSD to up MSD |
up $25 million to $75 million |
up $25 million to $75 million |
Data source: Raytheon Technologies presentations. LSD is low-single digits, MSD is mid-single digits, and HSD is high-single digits.
Synergy improvement
The merger that created Raytheon Technologies in 2020 is the largest in the history of the aerospace industry, and management has had to do it in the middle of the pandemic. It comes on the back of the United Technologies acquisition of Rockwell Collins in 2018 and the $16.4 billion deal to buy Goodrich in 2011. Given a history of successful integrations, it's reasonable to expect that Raytheon Technologies will be a success too.
The early indications are that this will be the case. For example, Hayes and Mitchill said cost synergies from the Rockwell Collins deal totaled $510 million since November 2018, and management is aiming for $600 million. Furthermore, Hayes announced that he now expects $1.3 billion in cost synergy from the creation of Raytheon Technologies, compared to a previous estimate of $1 billion.
Raytheon Technologies needs air travel to recover. Image source: Getty Images.
Demand could come back sooner than expected
Finally, Hayes gave some fascinating color during the earnings call. He noted that it would be normal to expect a "three to six months" lag between aftermarket demand and an increase in passenger miles traveled. However, he noted that aftermarket demand got "remarkably better" after the vaccine rollouts, with airlines rushing to get parked aircraft ready for the summer selling season.
If this trend continues and replicates when Europe starts opening travel up again, there's potential for significant improvement.
Looking ahead
All told, there are more positives than negatives in Raytheon's earnings, and investors shouldn't get too hung up on a quarter or two's revenue prospects. The company remains firmly on track for long-term recovery, and the stock is one of the best ways to play the commercial aviation market right now.
