Military equipment maker Raytheon Technologies (RTX -1.46%) reported what the Wall Street wizards refer to as a "mixed quarter" last week. Earnings came in ahead of expectations, but sales fell short. This was good enough to send Raytheon's stock price up about 1% on initial review, but not good enough to keep it up.
Since Raytheon informed investors of its Q1 2022 results, Raytheon stock has given up its early gains. Through the end of last week, it actually ended down 4.3% from its pre-earnings price. But why?
Raytheon by the numbers
For fiscal Q1 2022, Raytheon reported:
- Sales up 3% year-over-year at $15.7 billion (but below Wall Street's prediction of $15.8 billion).
- Pro forma profits up 28% at $1.15 (where Wall Street had expected only $1.01 per share).
- And GAAP earnings of $0.74 per share -- worse than the pro forma number, but at the same time up 45% year-over-year.
Raytheon credited a "strong commercial aerospace recovery" as the main reason it was able "to deliver both top-line growth and margin expansion year-over-year." Indeed, it was the company's commercial aerospace businesses that performed best in the quarter:
Collins Aerospace, which builds airplane parts and avionics and is the company's biggest business by revenue, got even bigger during the quarter, growing sales 10%, expanding its operating profit margin to 9.1%, and growing operating profits 40%. Similarly, Pratt & Whitney, which builds jet plane engines, saw sales surge 12%, lifted its profit margin from a meager 0.5% into the more respectable low-single-digits range (3.3%), and saw profits explode higher as a result -- up 655%.
In contrast, the defense businesses at this defense contractor lagged in Q1. Raytheon Intelligence & Space (sensors and cyber) saw sales shrink 5% year-over-year. Despite a small improvement in profit margins, operating profits slipped by 3% at this business. And sales at Raytheon's similarly sized Missiles & Defense division -- responsible for manufacture of the Javelin anti-tank weapons and Stinger air defense missiles that have been in the headlines so often these past two months -- actually declined even more, falling 7%, and with a steep reduction in profit margins (now 11%) and a consequent 22% year-over-year decline in operating profits.
Raytheon's worst number of all
Rounding out the bad news, Raytheon generated only a bare $37 million in real free cash flow for the quarter. That was just 3% (!) of reported net income, and about an 89% decline from last year's $336 million in Q1 FCF.
Granted, evaporating free cash flow has been a recurring theme in the industrials sector this quarter, as companies build inventories to minimize the effects of supply chain disruption. At Raytheon, inventory build subtracted $587 million from what could have been free cash flow in the quarter (five times what Raytheon spent on inventories a year ago). In a post-earnings conference call, (thanks to our friends at S&P Global Market Intelligence for this transcript, by the way), Raytheon noted that in Q1 it built up inventories of, in particular, "titanium forgings and castings" from Russia ahead of anticipated economic sanctions. In theory, this cash should return in the form of improved free cash flow later in the year, as Raytheon uses these parts to build equipment for sale.
Indeed, according to management, despite the weak FCF in Q1, Raytheon still expects to generate positive free cash flow on the order of $6 billion through the end of this year.
What comes next
Speaking of predictions, Raytheon CEO Greg Hayes insisted he's still "confident in the long-term outlook for our businesses, supported by the return to travel and growing global defense budgets." Guiding investors on what to expect over the remainder of 2022, he predicted that:
Sales will grow at least 5% this year, to somewhere between $67.8 billion and $68.8 billion. Management noted that this is about $750 million less business than the company had hoped to do this year, and blamed the expected shortfall in sales on "global sanctions on Russia" (which will impact sales of engines, parts, and services to Russia's airline industry). He noted that "adjusted" earnings per share will therefore be only $4.60 to $4.80 this year. That's about a dime short of Wall Street estimates, and probably another reason investors weren't overly enthusiastic about the earnings report last week.
As regards free cash flow, however, Hayes's prediction of $6 billion in FCF is almost precisely what Wall Street has been expecting. Let's just hope Raytheon can get there before the year is over.