The aerospace and defense company RTX (RTX 0.73%) had a difficult 2023 with issues in both end markets. That said, investing is about looking forward, not backward. So, is RTX worth buying as a recovery play for 2024? Here's what you need to know.
RTX's difficult year
The industrial stock will report its fourth-quarter 2023 earnings on Jan. 23, but investors already have a clear idea about what happened last year.
If you compare the full-year headline guidance given on the third-quarter earnings call in October with the guidance given at the start of the financial year, you might think RTX had an uneventful 2023.
|
RTX Full Year Guidance |
January |
October |
|---|---|---|
|
Sales |
$72 billion to $73 billion |
$74 billion |
|
Organic sales growth |
7% to 9% |
10% |
|
Adjusted EPS |
$4.90 to $5.05 |
$4.98 to $5.02 |
|
Free cash flow |
$4.8 billion |
$4.8 billion |
Data source: RTX presentations.
It was anything but. There are three key factors to consider, one positive and the others negative.
The three keys to 2023
First, general trading conditions in its commercial aerospace businesses, Collins Aerospace and Pratt & Whitney, were better than expected, and both segments are set to deliver more profit than was forecast at the start of the year.
Second, Pratt & Whitney engines (primarily the geared turbofan, or GTF engine, used on the Airbus A320 neo family and other planes) were found to have potentially been made with contaminated powder coating. As such, there's a need for 600 to 700 incremental shop visits stretching from 2023 to 2026 so engines can be removed and inspected.
Unfortunately, the issue will hurt net operating profit by $3 billion to $3.5 billion and cause a $3 billion cash hit from 2023 to 2025. Consequently, RTX took down its long-held target of $9 billion in free cash in 2025 to $7.5 billion on the update in September.
At this point, it's worth noting that back in July, CEO Greg Hayes had told investors, "We've got two years to work through that, and we will figure that out, but in terms of the cash, really probably not a big difference as you get out to 2025." Unfortunately, that statement proved too optimistic.
NYSE: RTX
Key Data Points
Third, management's guidance around its defense business also was too optimistic for the second year running. The issues in 2022 proved to be similar to those in 2023. Soaring raw material costs alongside supply chain and labor issues have pressured margins across the defense industry, noticeably in fixed-price programs that were inked in less inflationary times.
It's a common problem in the industry, and even though the supply chain has improved, and Raytheon (RTX's defense-focused business) has strong order momentum and backlogs, chief financial officer Neil Mitchill was still saying in October: "While inflation has begun to moderate, there are still pockets that remain persistently high within our manufacturing base. We expect this to continue into the next year."
What to expect in 2024
Having discussed the company's business trends, it's time to return to the question asked in the headline, and I think the answer, unsatisfactorily, is "hold."
RTX's commercial aerospace-focused business, barring the engine inspections issue, has excellent momentum going into 2024. While the growth rate will inevitably slow from the kind of mid-teens percentage expected for Collins Aerospace and Pratt & Whitney in 2023, it's still likely to be reasonable growth as flight departures continue to recover.
In addition, at some point, the supply chain issues and inflation pressure in the defense businesses will surely be alleviated, so RTX should be able to convert on its backlog at a higher margin.
Image source: Getty Images.
There's reason for optimism over RTX in 2024. However, there's also a note of caution around the company concerning the engine inspection issue. As noted above, management's initial assessment was too optimistic, and management has overpromised and underdelivered in defense over the last couple of years.
As such, waiting for management's update on the inspection issue makes sense before buying in.
The good news is that RTX expects that the majority of incremental engine removals will occur in 2023 and early 2024, so hopefully there will be an update on the forthcoming report whereby investors can better determine expectations for the net impact of the issue.
