The aerospace and defense giant disappointed investors in 2023. Still, a snapshot of RTX (RTX +0.79%) at the end of 2024 could show a company in much better shape than it is now. If so, the stock could bounce back strongly next year. Here's what you need to know before buying the stock.
RTX stock in 2024
There are two key issues and questions that will drive RTX's share price in the coming year:
- What will be the final financial impact of inspecting and removing commercial airplane engines potentially manufactured with contaminated powder metal?
- When will the supply chain and labor issues ease in the defense businesses to enable margin expansion as RTX executes on its record backlog?
The two questions are critical for the company's progression toward its revised target of $7.5 billion in free cash flow (FCF) in 2025. As previously discussed, penciling in a valuation of 20 times FCF, a reasonable valuation for a mature industrial company, and the $7.5 billion leads to a price target of around $104 compared with the current price of $81.32, implying an annual return of 13% over the next two years. Include the dividend that currently yields 2.9%, and it comes to nearly 16%.
NYSE: RTX
Key Data Points
Engine inspections
The returns we've discussed are obviously attractive. Still, there's no guarantee that RTX will hit them. That said, investors should get more color on the first question -- engine inspections -- in the first half, while the latter issue will take longer to resolve.
Back in mid-September, management updated investors on the potential financial impact of the engine inspections between 2023 and 2026. Management continues to expect $3 billion in cash headwinds over the period.
While the inspections will run on over the next few years, two-thirds of the 600 to 700 incremental shop visits will occur in 2023 and "relatively early in '24," according to RTX COO Chris Calio on the last earnings call. Consequently, investors can expect an update on the inspections issue in the first half of 2024, something that will build confidence in the 2025 FCF projections.
Image source: Getty Images.
Defense industry woes
For the second consecutive year, RTX's defense businesses are set to deliver profits lower than management's expectations at the start of the year. The issue isn't backlog or orders. In fact, the former stands at a record, with $50 billion in backlog at the defense-focused Raytheon segment and its year-to-date book-to-bill stands at 1.17, implying strong growth in the coming year.
Instead, as CFO Neil Mitchill noted on the earnings call: "Raytheon continues to have productivity and mix challenges. This stemmed from a combination of the fixed-price development programs we have previously discussed as well as higher production costs." These issues are common in the industry, with Boeing also reporting similar issues. Defense companies have been saddled with margin compression on fixed-price programs, signed in less inflationary times, as soaring costs have hurt defense contractors.
Unfortunately, these issues won't moderate soon, and Mitchill talked of "persistently high" pockets of inflation in its cost base. As such, Raytheon is implementing "additional strategic initiatives to offset the pressure we expect to see in 2024."
What to expect from RTX in 2024
Investors can expect an update on the engine inspections in the first half of the year. Hopefully, what it says will strengthen the framework around the $7.5 billion in FCF in 2025 target. In addition, as the commercial aerospace recovery spreads to long-haul international routes, RTX should see the benefit in the lucrative widebody aftermarket.
Image source: Getty Images.
Turning to defense, the supply chain issues are clearing, just not at the rate that most expected in 2023. That could change in 2024, particularly as market expectations for a recovery in defense company margins are probably low after a disappointing 2023.
RTX remains an attractive stock for investors, including income-seeking ones, but it's a stock for the patient. Unfortunately, there's no quick fix to the supply chain issues. Until the data from the bulk of the engine inspections is in, there's always a shadow of uncertainty around the issue.
That said, RTX is moving in the right direction and there's good reason to believe it will be in a stronger position at the end of the year. The potential stock return from hitting its FCF target makes the stock attractive for value investors.
