RTX’s legacy defense business was about the only thing that went wrong in Q2 for the company that used to be called Raytheon.
RTX (RTX -0.67%), the giant aerospace conglomerate formed by the merger of the Raytheon defense company and United Technologies’ airplane business, reported miserable earnings last week. Despite sales growing 8% year over year, RTX suffered a steep 91% collapse in second-quarter earnings, reporting just $0.08 per share.
And yet, despite the bad news, RTX stock is up more than 9% since reporting these earnings. Why is that?
RTX’s Q2 by the numbers
Give investors some credit. On the face of things, RTX’s earnings looked pretty miserable last week. But reading even just a little beyond the headlines showed some significant improvements at RTX.
For example, sales in the quarter were up a respectable 8% — and would have been up 10% but for the fact that RTX finalized the sale of its non-core cybersecurity business last quarter. It was only the absence of that revenue stream that slowed revenue growth in Q2.
Similarly, RTX’s earnings might have been a lot stronger than what the company reported — $1.41 per share instead of $0.08 — but for $1.33 in “acquisition accounting adjustments,” litigation charges, charges for a “fixed priced development contract,” and other (hopefully) one-time charges to earnings the company took during the quarter.
Investors seem to have considered all of the above a sort of continuation of last year’s powder metal matter fiasco, which depressed 2023 earnings but has since been largely resolved. And rather than punish the company for past stumbles, they’re looking ahead to how RTX might look once these difficulties are in the rearview mirror.
RTX beyond Q2
By and large, past difficulties notwithstanding, the future does look pretty bright for RTX. Both of the company’s commercial airplane parts divisions showed strong growth in the quarter, with Collins Aerospace sales up 10% and operating profits up 24%, and Pratt & Whitney showing 19% sales growth and 136% profits growth. Profit margins grew strongly at both divisions, and indeed doubled year over year at Pratt.
Curiously, RTX’s worst-performing unit (and the reason net profits collapsed for the company as a whole) was its legacy defense business, the core of the company that used to be known as Raytheon. Defense sales declined 3% year over year, while operating profit margins were devastated, falling from 9.6% to just 2% in the second quarter. Operating profits plunged 80% year over year.
It was this Raytheon division that used to own (and no longer owns) RTX’s cybersecurity division, though, which explains the decline in sales. At the same time, it was the Raytheon division that took the huge $575 million charge to earnings for the aforementioned “anticipated termination of a fixed price development contract with a foreign customer.”
But for that charge, Raytheon’s earnings, too, would have risen year over year.
Is RTX stock a buy?
Don’t cry for RTX. With this issue and others behind it, the company’s future should look just fine. As management confided, backlogged orders total $206 billion in value, meaning RTX currently has roughly three years’ worth of contracts already in the bag.
Near term, too, things are looking good. After considering the sales increases in Q2, RTX raised guidance for this full year, and now expects to book more than $79 billion in 2024 sales. Forecasts for adjusted earnings (at least) are also on the rise, with management saying earnings should exceed $5.35 per share and may reach $5.45.
My real quibble with RTX isn’t the health of the business per se, but rather with the valuation of the stock. Even crediting RTX for all its promised “earnings” (and treating them as GAAP profit even when they might not be), the stock costs 22 times earnings, and more than 33 times forecast free cash flow of $4.7 billion. With analysts predicting the company will grow profits at only about 11% annually over the next five years, the best I can say for RTX is that it’s not the most overpriced stock on the market today.
It certainly doesn’t look like a bargain to me. And if, for whatever reason, it turns out that the company’s charges for “one-time items” are not in fact at an end (fingers crossed this doesn’t happen), and earnings don’t grow as fast as promised, RTX stock could be even more expensive than it already looks today.
For the time being, I won’t be investing in RTX stock.
