Why Raytheon Is Set to Soar in the Aerospace Sector

Back on the company’s investor meeting presentation in May, Raytheon Technologies(NYSE:RTX) management gave some attractive targets for investors. Based on the recent second-quarter earnings, the company is off to a great start in reaching them. As such, the stock looks like one of the best ways to play a recovery in commercial aviation. Here’s why.

Medium-term targets

In a nutshell, investors aren’t buying the stock for what the company is now, but rather what it will be in a few years. The investment thesis is simple. The defense-focused businesses (Raytheon Missile Defense and Raytheon Intelligence & Space) are in stable end markets that will provide low to mid-single-digit growth and reliable earnings and free cash flow (FCF).

Three missiles taking off.

Image source: Getty Images.

However, the really exciting growth opportunity comes from the commercial aerospace businesses (Collins Aerospace and Pratt & Whitney) and their opportunity to benefit from a multi-year recovery in commercial aviation.

Management expects Collins Aerospace (aerostructures, avionics, interiors, power systems, etc.) to grow at a compound annual rate of 6%-7% from 2020-2025, with Pratt & Whitney (aircraft engines and parts) growing at a 9%-10% compound annual rate over the same period.

Understandably, management has set the year 2025 for its targets because CEO Greg Hayes doesn’t think the air traffic will ultimately return to pre-pandemic levels before 2024. In addition, according to Hayes, around 40%-45% of Collins Aerospace’s aftermarket revenue is in the wide-body market — a market set to recover after the narrow-body market, as domestic flights are recovering faster than international.

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All told, management expects overall sales growth to be at a compound annual rate of 6%-7% from 2020-2025, leading to FCF of $10 billion or above in 2025. To put that figure into perspective, $10 billion represents around 7.7% of Raytheon’s market cap of about $129.8 billion. Put another way, based on the current market cap, Raytheon would trade on less than 13 times FCF in 2025 — a very attractive valuation.

Airplane taking off.

Image source: Getty Images.

Off to a good start

Many things can happen between now and 2025, but Raytheon is already on a good path. The recent second-quarter earnings were notable for a few reasons.

  • Management raised full-year sales, earnings, and FCF guidance ranges.
  • Hayes raised the gross cost synergy target from the merger that created Raytheon Technologies (the former Raytheon Company merged with the aerospace business of the former United Technologies in 2020) to $1.5 billion from $1.3 billion previously.
  • In addition, CFO Neil Mitchill said the cost synergy of $600 million related to the Rockwell Collins acquisition (the former United Technologies acquired Rockwell Collins in 2018) would be met in 2021, a year ahead of target.

Focusing on the guidance hike, full-year adjusted earnings per share (EPS) is now forecast to be $3.85-$4.00 compared to a previous forecast of $3.50-$3.70. Around half of the increase comes from a reduction in expected tax payments, with most of the other half coming from an improvement in Collins. Commercial aftermarket revenue was better than expected as commercial flight departures continue to recover.

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The good news on cost synergies continues a strong track record in the aerospace industry. For example, United Technologies achieved $600 million in cost synergy following the acquisition of Goodrich in 2011, a figure matched by the cost synergy from the Rockwell Collins acquisition in 2018. Meanwhile, the $1.5 billion in cost synergy that Hayes is targeting for the recent merger is $500 million above the target given at the deal’s announcement.

Airplane passengers seated inside of a commercial aircraft.

Image source: Getty Images.

A stock to buy?

Raytheon is off to a great start on its path to $10 billion-plus in FCF in 2025. Management has already increased its estimate for cost synergy since the investor meeting in May, and Collins Aerospace is already showing the benefit of an improving aviation market.

Meanwhile, Boeing and Airbus are planning production ramp ups in narrow-body aircraft — good news for Collins Aerospace’s original equipment manufacturing business. In addition, Pratt & Whitney’s geared turbofan engine on the Airbus A320 NEO family will also benefit from the Airbus production ramp up, and potential aftermarket revenue growth as engines get used.

All told, Raytheon remains one of the best ways to play a recovery in the aerospace market, and the stock has a lot of upside potential in the coming years.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.


View more information: https://www.fool.com/investing/2021/08/10/why-raytheon-is-set-to-soar-in-the-aerospace-secto/

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