Throughout the year, 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 – in fact, most industry analysts are predicting travel demand won’t regain pre-pandemic levels until 2023 – but the administration of the first vaccine in the United States this week, and in other countries that started last week, is starting to engender some hope that recovery in this industry can finally begin, even if on a gradual level. Even before COVID-19 began dominating the world’s attention, though, this is an industry that was already experiencing its share of trouble.
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. It’s been a few weeks now that the FDA formally approved the return to service of the MAX, which means that along with vaccine deployment, the two biggest barriers facing this industry have been removed, clearing the way for travel to pick up again as social and business activity finds its way back.
Often, being a contrarian by nature means looking past current pressures – and to be clear, there is a very long way for the Aerospace industry to go to get back to anything you or I might consider “normal” – and thinking about much longer-term trends. That means that industries that have been out of favor, but look like they could be in position to swing back, start to naturally look a bit more attractive, especially in the long term. While many of the most well-known names in the Aerospace industry have been hammered by the collapse in commercial travel, I think there are still 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. 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. This year has proven the value of RTX’s Defense business, as the last couple of earnings reports have shown that segment backstopped the entire company, putting in position to recover more quickly than other companies whose businesses are closely tied to Boeing. Strength in their Defense business helped their balance sheet absorb the hit earlier in the year 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 continue to 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 $108.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by nearly -74%, while sales dropped -24.3%. In the last quarter, earnings increased 45% while Revenues improved almost 5%. 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 -3.77%, but improved in the last quarter to 1.79%. I think this is a good reflection of the blow the company absorbed at the early stages of the pandemic, as well as the extent to which its defense business has been able to offset weakness on the commercial side.
Free Cash Flow: RTX’s Free Cash Flow has dropped throughout the year, from about $5.7 at the beginning of the year to $3.7 billion in the last quarter. This modest number translates to a Free Cash Flow Yield of 3.32%.
Debt to Equity: RTX has a debt/equity ratio of .45, which is very conservative, and marks a drop from 1.03 in the first quarter of the year. Their balance sheet shows a little over $10 billion (versus $8 billion at the beginning of the year) in cash and liquid assets against $31.2 billion in long-term debt (versus $45.3 billion at the end of the first quarter). Servicing their debt is no problem, but continued weakness in Net Income could keep putting 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 earlier this year, 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 have done this year, is generally a positive indication.
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 $103 per share. Earlier this year, my analysis provided a long-term target above $161 per share, meaning that RTX’s target price has dropped more than -60%; but it also means the stock remains significantly undervalued, with a little more than 45% upside from its current price.
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 downward plunge a peak at $93.50 in February 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. The stock managed to rally to about $73 in June before dropping back and settling into a consolidation range that kept resistance at around $61 until early November; since then the stock has rallied strongly, primarily on the heels of positive vaccine progress and optimism, to climb back to that June peak at around $73. The stock is now a little below that point, which means that a break above $73 should give the stock room to rally even further – possibly all the way to the 88.6% retracement line at $87. Immediate support should be between $69 and $67, based on previous pivot activity and the 50% retracement line. A drop below $67 could see additional downside to somewhere between $63 and $61 where the 38.2% retracement rests.
Near-term Keys: RTX’s balance sheet has actually gotten stronger in the last couple of quarters, 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 the potential for broad market-based volatility right now and moving into the next year. A drop below $67 would be a good signal to consider shorting the stock or buying put options, using $63 to $61 as attractive bearish trade targets while a a break above $73 could be a good signal to buy the stock or work with call options, with upside to about $80 at minimum on a bullish trade.