Key Insights: Why September Matters for RTX Investors

September could be a make-or-break month for RTX (RTX -0.29%), formerly known as Raytheon Technologies. In July, investors were hit with an investment punch to the solar plexus with the news that its Pratt & Whitney business would have to remove engines from service for inspection. However, it's possible management will be able to update investors on the issue this month. Here's why it's so crucial for investors. 

Issue on the geared turbofan

The issue relates to the possibility of contamination in powdered metal RTX makes and uses on turbine discs on the geared turbofan engine (GTF). The GTF matters to RTX, as it's one of two options on the Airbus A320neo aircraft -- one of the workhorses of the skies alongside the Boeing 737 MAX -- and its flagship airplane engine. 

The issue doesn't impact newer engines produced; the condition was only present in rare instances in engines produced between the fourth quarter of 2015 and the third quarter of 2021.

What needs to be done

The plan outlined in July calls for 200 engines to be removed for inspection by mid-September, with a further 1,000 engines needing to be removed and inspected in the next nine to 12 months. That's what's known so far, and it's also known that management estimates a $500 million hit to free cash flow (FCF) from the issue in 2023.

Will RTX hit its medium-term target?

However, what's not known is the magnitude of the impact on cash flow in 2024 or the extent of the issues, such as how many turbine discs will need to be removed and replaced. While CEO Greg Hayes told investors that there is "probably not a big difference as you get out to 2025" in terms of RTX reaching its target for $9 billion in free cash flow that year, it's far from certain that will be the case given the potential for lingering issues on GTF. 

The $9 billion is a crucial figure for investors to focus on. After all, if RTX hits it, then based on the current share price, the stock will trade on slightly less than 14 times its FCF -- a highly attractive valuation for a company likely to benefit from ongoing demand from commercial aerospace. In addition, RTX's defense businesses have a growth opportunity coming from the replenishment of equipment used in Ukraine and increased spending on defense in light of growing geopolitical tensions. 

Update coming 

Going back to the earnings call in July, Hayes also told investors that RTX aimed to get the initial 200 engines back by the middle of September, and by that time, "we'll have a much better feel for what is involved here. We'll have an opportunity to update everybody around that time."

Based on the data that comes back from the initial 200 engines, management should be able to have a better idea of the financial impact on 2024 from the remaining 1,000 engines that need to be removed and inspected. Hayes stated that he would have an idea of the cost impact by the time of the Q3 earnings call -- sometime in mid-October. 

As such, there's a critical period between mid-September and mid-October when investors need to watch out what management says in the coming weeks. 

Image source: Getty Images.

What it means for investors

While it makes sense to try and second guess what management will say, it's important to note that RTX's underlying business is improving. For example, management raised its full-year sales and earnings guidance on the back of an improving outlook in its commercial aerospace (RTX's aerospace rival General Electric also raised guidance for a similar reason), and there are signs of improvement in its defense-focused businesses, which are likely to come to fruition in the coming quarters. 

Management raised its full-year sales guidance by $1 billion from a range of $72 billion to $73 billion to a new range of $73 billion to $74 billion while raising the low end of its adjusted earnings-per-share (EPS) guidance to $4.95 to $5.05 from $4.90 to $5.05.  

Data source: Company presentations. *RTX rearranged its segments in 2023.

The table above shows the improvement in the outlook of the leading commercial aerospace-focused business -- Collins Aerospace. Meanwhile, RTX won $13 billion in net bookings across its defense businesses (which include Raytheon and military engines at Pratt & Whitney), resulting in a book-to-bill of 1.22 in the quarter and a $73 billion backlog. Moreover, management spoke of improving material flow in its defense business as its supply chain issues normalize. 

What next

A bullish viewpoint sees a limited impact in 2024 from the GTF inspections and management, highlighting ongoing improvements in commercial aerospace and the benefit of an easing supply chain in defense. Alternatively, a significant hit to cash flow in 2024 would bring into question management's target of $9 billion in FCF in 2025. 

The potential polarity of the outcomes means RTX is a must-watch stock in September.