One of the most-anticipated (or perhaps, most-hoped-for) reopening stories this year has come from the Aerospace industry, which includes commercial airlines. It comes as no surprise, really to say that in 2020 and the early part of 2021 the industry was one of the biggest, unquestioned losers in the stock market. The biggest portion of that drop came from the reality that the industry took some of the biggest drawdowns in the market starting in February 2020 as commercial travel dried up to practically nothing because of global shutdowns and shelter-in-place orders. As vaccinations increased and infection and hospitalization rates started to drop, a lot of economists and analysts pointed at this industry as one to watch, since many were predicting a recovery in travel demand as consumers started to exercise long-pent-up desires to get out, take vacations, and see family and friends.
The last month or so has seen some of that enthusiasm begin to temper a bit amid new spikes in both infections and hospitalizations. No matter how much we want COVID to be a thing in the past, the emergence of new variants stands as a testament to the reality that the pandemic is still here and still has to be accounted for. That reality has blunted optimism about the Aerospace industry, with commercial airlines recently disclosing that the Delta variant is having an effect on bookings and travel demand as we wind into the latter part of the summer. That could represent a risk not only to commercial airlines, but also to the companies that build the machines that power the entire industry.
There are two principle commercial airline producers in the world: Boeing and Airbus. Boeing spent practically all of 2019 dealing with the negative impact of fatal crashes of its popular 737 MAX jet that killed all passengers on board. Those crashes were attributed to failures in the planes’ sensor system, resulting in the global grounding of the jet all over the world as the company went back to the drawing board. The MAX was formally cleared to return to service by the FDA in December of last year, clearing the way for travel to pick up again as social and business activity finds its way back – unless new pandemic pressures prove to have a long-term, sustained effect.
Often, being a contrarian by nature means looking past current pressures and thinking about much longer-term trends. That normally means that industries that have been out of favor, but look like they could be in position to recover, start to naturally look a bit more attractive, especially in the long term. While many of the most well-known, commercial airlines in the Aerospace industry have been hammered by the collapse in consumer and business travel, there are also bright spots that have managed to buck that broader trend. Raytheon Technologies Corp. (RTX) is an example.
In the commercial airline segment, RTX’s biggest customer isn’t Boeing – it’s Airbus, which before COVID-19 became a global issue was drawing a number of Boeing customers to its business in the wake of the MAX grounding. It also is a major player in the government-funded Defense space, which has historically proven to be resilient and even resistant to economic downturns. The last year has proven the value of RTX’s Defense business, as the last few earnings reports have shown that segment backstopped the entire company, putting it in position to recover more quickly than other companies whose businesses are closely tied to Boeing. Strength in their Defense business didn’t completely offset Commercial travel losses in 2020, but they did nonetheless help their balance sheet absorb the hit that prompted management at other companies in this industry to take drastic measures, including eliminating dividend payouts to preserve cash. The company completed a merger in April of 2019 with Raytheon, which increased its defense and intelligence business to nearly 60% of annual revenues. That gives RTX a backstop of revenue and cash flow that has enabled it to exercise patience with its commercial business, and that most other companies in the industry probably don’t have. The market has recognized RTX’s strength this year, pushing its price from a November 2020 low at around $52 to a high in June at around $90. With the stock now sitting just a little below that high, the big question now is simple: is the stock also a good value, or has its strength over the last nine month pushed the stock too high? Let’s find out.
Fundamental and Value Profile
Raytheon Technologies Corp, formerly, United Technologies Corporation is engaged in providing high technology products and services to the building systems and aerospace industries around the world. The Company operates through segments such as Pratt & Whitney and Collins Aerospace Systems. The Pratt & Whitney segment supplies aircraft engines for the commercial, military, business jet and general aviation markets. Pratt & Whitney segment provides fleet management services and aftermarket maintenance, repair and overhaul services. The Collins Aerospace Systems segment provides aerospace products and aftermarket service solutions for aircraft manufacturers, airlines, regional, business and general aviation markets, military, space and undersea operations. RTX has a current market cap of $133.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 157.5%, while sales rose nearly 13%. In the last quarter, earnings increased 14.44% while Revenues dropped 4.12%. RTX’s Net Income versus Revenue shows the impact of global economic shutdowns earlier in the year, as well as the company’s reversal of that impact; over the last year this number was a marginal 3.51%, but improved in the last quarter to 6.5%. These numbers actually reflect tangible improvement versus a few months ago, when the annual figure was -4.44% and the quarterly was 4.65%. The last four quarterly numbers, in fact have been positive, which is a good reflection of the extent to which its defense business has been able to offset weakness on the commercial side for the past year.
Free Cash Flow: RTX’s Free Cash Flow had dropped throughout most of the past year before the company’s latest earnings report, but appears to be strengthening again, at about $3.3 billion in the last quarter from about $2.6 billion in the quarter prior. A year ago, this number was about $3.7 billion, so the positive turn looks like good confirmation of the company’s improvement in Net Income. The current number translates to a modest Free Cash Flow Yield of 2.48%.
Debt to Equity: RTX has a debt/equity ratio of .41, which is very conservative, and marks a drop from 1.03 in the first quarter of 2020. Their balance sheet shows a little over $8 billion (versus $8.6 billion a quarter ago) in cash and liquid assets against $29.9 billion in long-term debt (versus $45.3 billion at the end of the first quarter of 2020). Servicing their debt is no problem, but continued recovery in Net Income is needed to keep pressure off of the company’s liquidity.
Dividend: RTX pays an annual dividend of $2.04 per share, which at its current price translates to a yield of 2.33%. It should be noted that early in 2020, management announced it was reducing the dividend from $2.94 to $1.90 per share, a cost-cutting measure that can be interpreted as positive or negative depending on your general view. Management raised the dividend two quarters ago, which I take as a sign of increasing strength.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $100 per share. Earlier this year, my analysis provided a long-term target around $84 per share, meaning that RTX’s target price has strengthened nicely, and that the stock is actually undervalued at its current price, by about 13%. It also puts a practical bargain price at around $80 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line defines the stock’s upward trend from its November 2020 low to its peak, reached in June at around $90 per share. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. Immediate resistance is at the 52-week high, with the stock currently just about $1.50 below that mark, with current support at around $86 based on a pivot low at the beginning of this month. A push above $90 should see about $4 of near-term upside (using the distance between current support and resistance levels as a reference), while a drop below $86 should find next support at around $84, with additional downside to about $81 if bearish momentum accelerates.
Near-term Keys: RTX’s balance sheet has remained solid through the last year, despite the sizable headwinds in its commercial business, and the inevitable impact they carried over the course of the past year and a half. I think that resilience is largely a reflection of the company’s operations in the Defense space and aggressive cost-cutting measures it took during the pandemic in its commercial business, along with the fact that it isn’t heavily reliant on Boeing on the commercial side. It is also interesting that, despite the stock’s increase in price over the last several months, the value proposition is interesting, if not quite compelling. The airline industry does makes for a good reopening story, but recent events are a clear reminder that doesn’t mean that these stocks won’t continue to be volatile. If you prefer to focus on short-term trading strategies, a pivot high at $90 could be a good signal to consider shorting the stock or buying put options, using $86 as an attractive bearish trade target, while a a break above $90 could be a good signal to buy the stock or work with call options, with upside to about $94 on a bullish trade.