Last week must have felt like a lousy time to own shares of RTX (RTX -0.29%) stock.

The giant defense contractor once known simply as Raytheon announced it had beaten second-quarter earnings estimates, with sales coming in more than $600 million ahead of analyst forecasts, and earnings beating by more than a dime. But it also announced its earnings and free cash flow in the future could be quite a bit less than even the most pessimistic analysts had been hoping.

Even worse, the main reason for the downbeat forecast was RTX's own fault.

RTX earnings by the numbers

Let's start with the good news.

For Q2, RTX reported quarterly sales of $18.3 billion, up 12% year over year -- all of which was organic growth. Sales are going so well, in fact, that RTX raised its sales guidance for the rest of 2023, and now expects to end the year with sales between $73 billion and $74 billion, as much as a 10% improvement over 2022.

Earnings per share inched 2% higher year over year to $0.90 due to accounting adjustments. Adjusted to back out those accounting quirks, pro forma earnings would have been up 11% year over year at $1.29 per share. And Raytheon raised its estimate for pro forma earnings this year as well -- to about $5 a share.

This, as I say, is the good news.

The bad news is that free cash flow at RTX took a bit of a tumble, with operating cash flow falling 44% year over year. Capital spending was up significantly and, as a result, free cash flow fell to just $193 million -- a 76% year-over-year decline. (Free cash flow through the first half of the year is now negative $1.2 billion.)

And then there's the worse news.

Raytheon's big goof

"Pratt & Whitney [will need to temporarily] remove certain engines from service for inspection earlier than expected," lamented management last week, because of "a rare condition in powder metal used to manufacture certain engine parts."

Specifically, "a significant portion" of the PW1100G-JM engines that RTX produced and delivered in years past, which were then installed on Airbus A320neo airplanes, will need to be removed and inspected over the next nine to 12 months.

And by "significant portion," RTX means anywhere from 200 to 1,200 engines. This epic goof is therefore going to ground anywhere from 100 to 600 of Airbus' most popular planes -- and cost RTX as much as $500 million in free cash flow this year as it pays for the inspections and compensates its customers for the inconvenience.    

What it means to RTX -- and you

The company's stock price fell 10% on the day of this announcement and has only gained back about 1% in the week since. But precisely how bad is this news?

RTX went into some detail on its dilemma in the company's post-earnings conference call.

The problem stems from powdered metal parts (mostly, turbine discs in the engine) that suffered some unspecified "rare condition" involving "contamination," which calls their integrity into question. To assess precisely how compromised the parts have become, over the next two months, RTX will need to ground about 100 Airbus planes (each A320 has two engines) and remove their engines for inspection. Then over the next 9 to 12 months, a further 1,000 engines may need to be similarly inspected. "Clearly," said CEO Greg Hayes, "this will have an impact on Pratt & Whitney and our customers."

And $500 million in free cash flow lost this year will be only the start of it. 2024's costs could be even larger.

As bad as all of this sounds, though, it's important not to overstate the crisis. Chief Operating Officer Chris Calio confirmed that "current production of powdered metal parts is not impacted." In other words, this is a problem that happened (beginning around about the fourth quarter of 2015), that then stopped happening (in the third quarter of 2021, a year after Raytheon acquired United Technologies, the parent company of Pratt & Whitney), that was then discovered, and is now being remediated.

Because the problem is not ongoing, RTX can still "continue to deliver both new engines and new spare parts across all product lines." At the same time, the company is increasing inspections of its production lines to ensure the problem does not come back.

It's also worth highlighting that even accounting for the costs of fixing this problem, RTX expects to grow its operating profits this year -- by as much as $200 million to $275 million. This implies the company will generate at least $7.4 billion in operating income, and probably net profits on the order of $5.4 billion, giving the stock a current year valuation of roughly 24 times earnings.

Investing minds can still differ on whether this is a good price to pay for a company that's got a pretty rough year ahead of it -- probably dominated by headlines describing plunging cash generation and charges to generally accepted accounting principles (GAAP) earnings that could keep a lid on any stock price gains. That being said, long-term, the business remains sound, the free cash flow positive, and the earnings copious.

This is a problem no doubt. But it's not a big enough problem to kill the business, or ruin RTX stock as an investment.