2023 was not kind to defense contractor Raytheon.
Stung by a manufacturing snafu involving "a rare condition in powder metal used to manufacture certain engine parts," the company announced in August that it would pull anywhere from 200 to 1,200 of its already-installed PW1100G-JM engines from commercial airplane engines for inspection. The decision incurred costs for conducting the inspections, interrupted the company's sales pipeline for new engines, and caused Raytheon stock to lose about 17% in a year when the S&P 500 was up 24%.
It may or may not also have played a part in the company's decision to rebrand itself as RTX Corporation (RTX -0.29%) -- a name change that it announced only one month before revealing the manufacturing defect.
RTX in 2023
How bad was the damage to RTX's reputation and its profit-and-loss statement? Management gave us the final damage report on Tuesday this week. In 2023, RTX sales grew a bare 3% to $68.9 billion. "Adjusted" earnings, which pretend the PR disaster never happened, grew a respectable 6%. But when calculated according to standard generally accepted accounting principles (GAAP), the company's earnings actually declined a steep 36% to $2.23 per share.
Oof.
Now, here's the good news: In the course of admitting to those weak full-year numbers, RTX was also able to report some pretty significant improvements in its operations in the final quarter of last year. For Q4 2023, sales grew three times as fast as for 2024 as a whole -- up 10%. Adjusted earnings were weaker -- up only 2%. But the more important GAAP number basically kept pace with sales growth, up 9% year over year.
Best of all, whereas RTX blamed the "powder metal matter" up and down for its weak full-year results, once the press release discussion turned to Q4 in particular, RTX suddenly stopped talking about "powder metal" entirely. It's as if the snafu never even happened.
That seems a strong signal that RTX has finally moved beyond the crisis and is back to business as usual. Indeed, in its post-earnings conference call with analysts, RTX confirmed this, stating: "Today, all ... engines being delivered to our customers ... contain disks produced from powdered metal manufactured after Q3 2021" (i.e., after the defective metal was no longer being used).
RTX in 2024
So, what will a business-as-usual 2024 look like for RTX? Well, the powder metal matter will continue to affect results somewhat. In its conference call, RTX noted that in 2024, it still expects to incur payments of about $1.3 billion total related to past powder metal liabilities.
Despite these payments, though, it does really look like RTX is growing again. Sales for fiscal 2024 are expected to range from $78 billion to $79 billion -- up a strong 14% over 2023 sales at the midpoint of that range.
Valuing RTX stock
Management didn't give a GAAP forecast for 2024 earnings but did say that its adjusted profits (presumably, "adjusted" to not count all the costs of putting the powder metal matter to bed once and for all) should come in somewhere between $5.25 per share and $5.40 per share. So, subtract $1.3 billion from that, divide by the company's 1.4 billion shares outstanding, and we're probably looking at GAAP per-share profits of about $4.40 this year.
On a $90.50 stock, that works out to a price-to-earnings (P/E) ratio of about 20.5.
Is that a fair price to pay for Raytheon, er, RTX stock?
I mean, I suppose you could make that argument, especially in the context of a wildly overvalued stock market. At last report, the average S&P 500 stock was selling for 26.5 times trailing earnings, and RTX shares at least cost less than that.
Even so, to a value investor like me, 20.5x earnings seems a lot to pay for 14% growth. I also can't help but notice that RTX stock sells for 1.9 times trailing sales, which is nearly twice what I ordinarily like to pay for a defense contractor (which is 1.0x annual sales).
What really knocks RTX stock out of contention for me, though, is that management is forecasting that it will generate only $5.7 billion in positive free cash flow this year. RTX, you see, has a huge pile of debt on its balance sheet -- enough to push its relatively svelte $128 billion market capitalization up to a $167 billion enterprise value. With net debt factored in, RTX stock is selling for more than 29 times current year free cash flow, which is a valuation nearly 50% more expensive than the stock's apparent P/E (and, incidentally, a bit more than the average S&P 500 P/E).
When you get right down to it, RTX may be a fine company, and it may finally be back on track, with the powder metal matter now (mostly) behind it, to grow consistently and profitably from here on out. But it's not selling for a bargain price at all.
And that's why I won't be buying RTX stock today.
