Raytheon Technologies (RTX -0.29%) stock has been stuck in a bit of a rut. It's down nearly 4% this year and only up 4.7% over the last year -- significantly underperforming the S&P 500 across both time frames. The company has had some issues over the previous year, but I think some recent news makes the stock a good buy for long-term investors.
Why Raytheon has underperformed
Raytheon, which recently started branding itself as RTX, should be doing great. After all, the commercial aerospace market is recovering strongly, with domestic flights already back to 2019 levels (the year before the pandemic) and international flight departures building a solid recovery. Meanwhile, defense spending will likely pick up substantially due to geopolitical tensions, NATO expansion, and the need to replenish equipment used in the conflict in Ukraine.
While those factors apply and make RTX an attractive company, it makes no investing sense to gloss over the headwinds the company has faced and continues to face.
I would classify these issues into three interconnected buckets, and I'll deal with each in turn below:
- Significant raw material, labor cost inflation, and other headwinds
- Supply chain headwinds that have made it difficult to deliver products on time
- Operational issues around the geared turbofan (GTF) engine at Pratt & Whitney
Cost, headwinds, and operational issues
RTX's headwinds are significant. For example, during the investor day presentation in 2021, management gave the numbers around its plan for 2025. It expected cumulative cost reduction savings of $5.1 billion. Meanwhile, a combination of labor, commodity, customer concessions, and "give-backs" were expected to total $3.1 billion, meaning the net cost reduction would be $2 billion.
However, since then, there's been an incremental increase in the expected headwinds of $1.3 billion. Keep that figure in mind because I will return to it later.
The supply chain headwinds have also created issues. For example, while orders remain strong in the defense businesses, Raytheon Missiles & Defense (RMD) is having issues delivering due to needing more inventory in its factories. Management started 2022 expecting sales "slightly up" on the $15.5 billion reported in 2021, only to end up with $14.9 billion, as RMD struggled to procure inventory.
Finally, the issues with GTF (Pratt & Whitney's flagship engine and one of two options on the Airbus A320 neo family of aircraft) include a part that will need to be taken off and replaced -- resulting in a $500 million hit to cash flow in the first quarter.
Image source: Getty Images.
Cash flow and supply chain issues
While these issues are concerning, it's important to contextualize them. Firstly, the $500 million will likely be recovered in the third quarter as GTF deliveries recover, according to RTX Chief Operating Officer Chris Calio.
Second, while the supply chain issues are still a problem, it hasn't caused any let-up in orders, and the defense businesses (which will soon be called Raytheon as the overall company is rebranded to become RTX) has a book-to-bill ratio of 1.32 times. In other words, the current bookings are 1.32 times the last 12 months' revenue.
The $500 million boost
Finally, going back to the figures I mentioned earlier, while management said there would be an incremental $1.3 billion in headwinds to 2025, it also said "RTX is raising its gross cost synergy target from $1.5 billion to $2 billion."
As previously noted, management has a superb record of generating cost synergies out of acquisitions and business realignments, so it's no surprise to see an increase in its estimate following the announcement of a restructuring of the business from four segments (Collins Aerospace, Pratt & Whitney, RMD, and Raytheon Intelligence & Space, or RIS) into three (Collins Aerospace, Pratt & Whitney, and Raytheon).
Ultimately, when all the puts and takes are worked through, the company increased its estimated net cost reduction to 2025 from $2 billion to $2.2 billion. The $2.2 billion represents 3.3% of the $67 billion in sales.
Image source: Getty Images.
What it means to investors
All told the $500 million increase in expected cost synergies will offset the increase in cost headwinds and help the company meet its medium-term target of raising its segment profit margin from 9.9% in 2022 to between 13.6% and 14.6% in 2025 and generating $9 billion in free cash flow in the same year. With supply chain issues and GTF problems likely to ease and end markets continuing to grow, the stock remains attractive for investors.
