Over the last several months, the Aerospace industry, which includes commercial airlines has been one of the biggest, unquestioned losers in the stock market. Yes, the biggest portion of that drop comes from the reality that the industry took some of the biggest drawdowns in the market starting in February as commercial travel dried up to practically nothing because of global shutdowns and shelter-in-place orders. Pressures continue to exist as airlines are pushing a big boulder uphill, trying to motivate consumers to resume air travel by beating the safety drum while the world holds its breath waiting for a practical vaccine to finally be made available against the virus. Even before COVID-19 began dominating the world’s attention, though, this is an industry that was already experiencing its share of trouble.
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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. As of this writing, the 737 MAX has still not been returned to service; in May Boeing ordered its primary turbine suppliers to halt production. Work has resumed on the Max, and if it passes regulatory review, it appears it could be returned to service by the end of the year. How long it will take airlines to start ramping up demand is a different kind of question, as travel demand is forecasted to not begin increasing until 2021, and not to return to 2019 levels for three to five years, depending on which “expert” you listen to. Either way, the near-term prospects for Boeing, and therefore the entire Aerospace industry still don’t look very favorable.
This is where sometimes my contrarian nature sometimes proves useful. I certainly don’t downplay the seriousness of the global pandemic. I also agree that airline travel is one part of a “return to normal” that we aren’t going to see for a couple of years at least. That said, the negative pressure these elements have put on the industry have pushed prices on stocks throughout the Aerospace industry to extreme lows.
Being a contrarian means that even in seriously depressed industries, I’m used to sifting through through a lot of data to dig the occasional gem out of what might otherwise look like a complete wreck to everybody else. In Aerospace, I think there are still bright spots to find opportunity right now. 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. It also is a major player in the government-funded Defense space, which has historically proven to be resilient and even resistance to economic downturns. I believe the upshot is that while the commercial side is likely to remain under pressure for the foreseeable future, it will probably also recover more quickly than other companies whose businesses are closely tied to Boeing. As of their most recent earnings report in early May, the strength in their Defense business helped their balance sheet absorb the hit in the last quarter that in many other cases has prompted management to take drastic measures, including eliminating dividend payouts to preserve cash. The company completed a merger in April of this year 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 will enable it to exercise patience with its commercial business, and that most other companies in the industry probably don’t have. Is the stock also a good value? 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 $98.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by nearly -82%, while sales dropped -28%. In the last quarter, earnings dropped -77.5% while Revenues decreased almost -23%. RTX’s Net Income versus Revenue shows the impact of global economic shutdowns; over the last year this number was -2.28%, and dropped in the last quarter to -27.27%. I think Net Income does bear watching carefully in the quarters ahead; a continued decline in this measurement will put heavier pressure on their balance sheet, which for now is healthy enough to absorb it.
Free Cash Flow: RTX’s Free Cash Flow remains healthy, at a little more than $3.7 billion. This does mark a drop from the last quarter, when Free Cash Flow was $5.7 billion, and translates to a Free Cash Flow Yield of 7.52%.
Debt to Equity: RTX has a debt/equity ratio of .48, which is very conservative, and marks a drop from 1.08 in the quarter prior. Their balance sheet shows a little over $8 billion in cash and liquid assets against $32.9 billion in long-term debt (versus $45.3 billion in the quarter prior). Servicing their debt is no problem, but continued declines in Net Income could put pressure on the company’s liquidity.
Dividend: RTX pays an annual dividend of $1.90 per share, which at its current price translates to a yield of 3.31%. It should be noted that in the last earnings report, management announced it was reducing the dividend from $2.94 per share, a cost-cutting measure that can be interpreted as positive or negative depending on your general view. Under current circumstances, I think the fact that the dividend was reduced, and not eliminated, which many companies are doing right now, is generally a positive indication, but it does mean that the company’s next couple of earnings reports bear watching as well.
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 $161 per share. That means that RTX is massively undervalued, with a little more than 184% upside from its current price. RTX’ current target price is far above the level I identified before the most recent earnings report, when I put their “Fair Value” price at around $132 per share.
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 downward trend from the third quarter of 2018 to its low point in March at around $41. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. RTX had been following a modest, intermediate upward trend through the last half of 2019, peaking at about $92, before collapsing to its March low under the weight of COVID-19-induced concerns. The stock picked up bullish momentum from that point, rallying to a high above the 50% retracement line at around $67 before dropping back again until mid-May. From that point, the stock pushed up to the 61.8% retracement line and appeared to be picking up bullish momentum until market uncertainty pushed the stock back to near the 38.2% retracement line, where it hovered until the last week, and appears to be increasing in bearish momentum right now. Support should be around $53 based on a pivot low in May, with immediate resistance at $61. A push above $61 should give the stock room to rally to about $67, while a drop below $53 could give the stock enough momentum to test low ranges between the March low around $40 and $45.
Near-term Keys: RTX’s balance sheet remains pretty strong, despite the sizable headwinds in its commercial business, and the inevitable impact they carried in the last quarter. I think that resilience is a reflection of the company’s operations in the Defense space, as well as the fact that it isn’t heavily reliant on Boeing on the commercial side. I also really like their value proposition, but don’t ignore the stock’s exposure to broad market-based volatility right now. A drop below $53 would be a good signal to consider shorting the stock or buying put options, using $45 to $40 as attractive bearish trade targets while a a break above $61 could be a good signal to buy the stock or work with call options, using $67 as a good short-term profit target on a bullish trade.
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