With a land war in Europe, 2022 should have been a busy year for defense contractor Raytheon Technologies (RTX -0.04%). But that's not how things are working out so far.
In Raytheon's second-quarter 2022 earnings report released last week, the company barely beat analyst expectations on the bottom line, reporting $1.16 per share when the Street had expected $1.12. The top line, meanwhile, was a clear miss. Sales for the quarter came in at just $16.3 billion -- $300 million short of the consensus. Upon seeing this, investors sold off Raytheon stock -- now down 2.5% since earnings were released.
And yet, Raytheon remains optimistic.
Raytheon by the numbers
In a textbook case of mixed earnings, Raytheon reported weak sales growth of just 3% year over year. Earnings, however, were up -- either a 16% rise to $1.16 per share if you're using adjusted earnings, or a 28% improvement to $0.88 per share according to generally accepted accounting principles. (The difference between the two comes down to a handful of one-time charges.)
So, is this good or bad news for the defense contractor's business? It really depends on which part of the business you're looking at. Raytheon's two biggest businesses, Collins Aerospace and engine maker Pratt & Whitney -- both of which do a lot of sales to the civilian sector and the military -- saw Q2 sales rise 10% and 16%, respectively. Operating profit margins on those sales slipped only a bit at Collins, down 20 basis points to 10.9%. At Pratt, however, profit margins more than doubled year over year, albeit to a lowly 6.1% -- where it remains Raytheon's least profitable business.
In contrast, Raytheon's smaller, more military-focused Intelligence & Space and Missiles & Defense businesses -- the two you'd expect to be most in demand in a time of global conflict -- saw sales decline in Q2, down 6% and 11%, respectively. These two businesses used to be among Raytheon's most profitable. But in Q2, Intelligence & Space margins sank 210 basis points to just 8.8%, and Missiles & Defense margins crashed 360 basis points, falling to 9.8%.
Summing up the situation, management noted strong sales in civilian airplane parts as the airline industry ramps back up post-pandemic, but military sales have been surprisingly weak and hindered by "continuing supply chain constraints." Again, that's the opposite of what you might expect, but it appears to be the situation Raytheon must deal with today.
High hopes for free cash flow
Despite these difficulties, Raytheon is sticking with its prediction from the spring that the company will generate an astounding $6 billion in free cash flow this year. That seemed a pretty bold promise back in Q1 after Raytheon generated a mere $37 million in free cash flow. It's somewhat less surprising after the company reported generating $807 million in positive free cash flow for Q2.
However, $807 million is 16% less real cash profit than Raytheon generated a year ago. It still leaves the company with just $844 million generated in the first half of the year -- $5.2 billion short of what it needs to generate in the second half to fulfill its promise, six times the cash it produced in the first half.
Can Raytheon really do that?
Perhaps. Generating $6 billion in free cash flow in a year wouldn't be entirely unheard of for Raytheon. Indeed, the company came out of 2019 with $7 billion in free cash flow -- although, over the past decade, it's averaged closer to $4.5 billion per year, according to historical data from S&P Global Market Intelligence. It's also encouraging that the company detailed in its earnings report no less than $7.8 billion in new orders recorded during Q2 alone -- orders for everything from Stinger and Tomahawk missiles and SPY-6 radar systems to F135 engines for new F-35 stealth fighter jets (and $1.2 billion worth of "classified bookings" besides).
That all sounds very promising. Still, it's undeniable that Raytheon is off to a very slow start this year. While I can't say Raytheon won't meet its goal, I must say management has its work cut out for it.