RTX Corporation: Grounded As The S&P 500 Has Rocketed Higher (2024)

A flip of the calendar can often be enough to change the market narrative. Decades-high inflation, the start of the rate hike cycle, and fears of a recession sent markets reeling in 2022, with the S&P 500 Index (SP500) falling 19%.

Now that disinflation is occurring, the markets are pricing in six 25-basis point rate cuts within the next 12 months as the most likely scenario. Unsurprisingly, this improved market sentiment has allowed the S&P to rally by 24% so far in 2023 as of December 26.

However, the vast majority of these gains (58%) have been driven by the Magnificent 7. If the market is going to keep chugging along, it will require market breadth.

RTX Corporation (NYSE:RTX), formerly known as Raytheon Technologies, is one stock that I own. Down 17% so far in 2023, RTX has been left in the dust by the market. It isn't hard to see why, either. RTX can be more appropriately categorized as a value stock in a market that has been most kind to growth in 2023. Not to mention that, as I will discuss, there is a company-specific headwind that has weighed on stock performance this year as well.

All things considered, though, I am initiating a buy rating on RTX. I will dig into the company's fundamentals and valuation to underline why.

Compared to the 1.5% yield of the S&P 500, I find RTX's 2.8% dividend yield to be appealing. This market-beating starting income also has the potential to grow further. This is because RTX's 46% EPS payout ratio is markedly lower than the 60% EPS payout ratio that rating agencies deem to be the industry-safe guideline.

Additionally, the company's 30% debt-to-capital ratio is materially less than the 40% debt-to-capital ratio that rating agencies like to see from the aerospace and defense industry. These factors explain why RTX currently possesses a BBB+ credit rating from S&P on a stable outlook.

For these reasons, Dividend Kings estimates the probability of the company cutting its dividend in the next recession at just 1%. In a severe recession, that risk rises to a still reasonable (in my opinion) 3%.

RTX checks the boxes for me in terms of fundamentals, but that's not all that I like about it. According to Dividend Kings' historical valuation metrics for RTX (e.g., dividend yield and P/E ratio), the stock appears to be worth $121 a share. Relative to the current $84 share price, this would represent a 31% discount to fair value.

Assuming that RTX meets the analyst growth consensus and returns to fair value, here are the total returns it could generate for the coming 10 years:

• 2.8% yield + 9.7% FactSet Research annual growth consensus + 3.8% annual valuation multiple expansion = 16.3% annual total return potential or a cumulative 353% 10-year cumulative total return versus the 8.6% annual total return potential of the S&P or a 128% 10-year cumulative total return

Outperforming Expectations Despite Setbacks

Before I dive into its third-quarter operating results, I believe it would be helpful to set the table by first briefly providing an overview of the company. RTX is among the largest publicly traded aerospace and defense contractors in the world.

As of July 1, the company was divided into the following three operating segments:

1. Collins Aerospace: This segment is a top seller of advanced aerospace and defense products for customers including airlines, aircraft manufacturers, and defense and commercial space operations. The segment sells products, such as aviation systems, electric power generation, flight control systems, and so much more. Through the first nine months of 2023, this segment accounted for $19.1 billion of net sales or roughly 39% of total company net sales including eliminations (all details for this segment and the two to follow were sourced from pages 25-26 of 182 of RTX's 10-Q filing).
2. Pratt & Whitney: The segment sells aircraft engines and auxiliary power units to airlines and the military. Also, it provides fleet repair and overhaul services to these customers. Adjusting for the impact of the powder metal matter on net sales, the segment's $11.9 billion in net sales comprised approximately 24% of RTX's total net sales through September 30, 2023.
3. Raytheon: This segment focuses on providing threat detection, tracking, and mitigation tools to world governments and commercial customers. The products that the company designs and develops include air and missile defense systems, missiles, space-based systems, and hypersonic weapons. The segment contributed the remaining $19.5 billion or just shy of 40% of total net sales for the first nine months of 2023.

RTX's results for the third quarter ended September 30 were admirable for the circ*mstances. The company posted $13.5 billion in net sales during the quarter, which was down 20.6% over the year-ago period. The good news is that this did beat the analyst consensus by $800 million.

Of course, this sizable downtick in net sales can be explained by the news earlier this year relating to Pratt & Whitney. The company became aware of a rare condition in powder metal that was used to manufacture certain engine parts (e.g., PW1100 geared turbofan engines, which power the Airbus A320neo). Thus, RTX took action to recall all 3,000 engines out of an abundance of caution. Due to the inspections and customer compensation, the company took a $5.4 billion charge in the third quarter to address these issues.

Factoring this out of the equation, RTX's net sales would have surged 11.8% higher to $19 billion for the third quarter. This was driven by a 15.9% growth rate in Collins' net sales to $6.6 billion. In his opening remarks during RTX's Q3 2023 earnings call, CFO Neil Mitchill attributed this to particularly strong growth in commercial OE and aftermarkets. Raytheon segment revenue also edged 2.6% higher year-over-year to $6.5 billion in the quarter.

Moving to the bottom line, RTX's non-GAAP EPS increased by 3.3% over the year-ago period to $1.25 during the third quarter. For context, this surpassed the analyst consensus by $0.03.

Looking ahead, RTX's fundamentals appear to be intact. That is because the company's backlog climbed by 8.6% from December 31, 2022, to $190 billion as of September 30, 2023.

RTX also looks to be fine financially. The company's interest coverage ratio of 3.1 may not seem particularly healthy. However, this isn't bad either considering the charge that it took with P&W.

Finally, RTX is taking the opportunity to buy its shares on the cheap, with a $10 billion share repurchase program. Against its current $119 billion market cap, this is an aggressive buyback program, signaling that the company is confident that shares are a steal right now.

A 30-Year Dividend Growth Streak

Since the merger between United Technologies and Raytheon was completed in 2020, RTX has upped its quarterly dividend per share by 24.2% to the current rate of $0.59.

Moving forward, I would expect dividend growth to closely approximate the most recent 7.3% dividend hike announced in April. This is because the analyst consensus for EPS in 2024 is $5.39. Compared to the consensus of $2.45 in dividends per share that are expected to be paid in 2024, this equates to a 45.5% payout ratio. This should leave the company with the flexibility to build upon the 30-year dividend growth streak that it inherited from its merger.

Risks To Consider

RTX is a blue-chip business, but it still faces risks.

The company does appear to be taking the right steps to remedy the situation within its P&W segment. However, there is always the risk that the company may not be successful in making the situation right. If that is proven to be the case over time, its brand trust could fade. That could materially alter RTX's overall fundamentals.

Another risk facing RTX and all major companies, in general, is that they are lucrative targets for hackers. The company takes its cybersecurity seriously, but there are no guarantees that RTX will be able to indefinitely prevent major breaches of its IT network. If a significant breach were to happen, this could compromise sensitive information, resulting in potentially sizable lawsuits and damage to its reputation.

Finally, RTX is exposed to the concentration risk. As of 2022, approximately 45% of its net sales were made to the U.S. government (page 7 of 169 of RTX 10-K filing). RTX must maintain a good working relationship with the U.S. government to keep delivering results to shareholders. If the company can't do this for any reason or the U.S. government loses faith in RTX, its fundamentals could be negatively impacted.

Summary: RTX Is An Interesting Risk/Reward Proposition

RTX's operating fundamentals and investment-grade balance sheet earn it an 11/13 quality rating from Dividend Kings. On top of this underlying quality, the company's shares appear to be discounted.

RTX Corporation's current P/E ratio of 16.7 is below its normal P/E ratio of 17.2 per FAST Graphs, which I believe offers a buying opportunity. If the company can revert to its normal P/E ratio and grow by 7% in 2024 and 19% in 2025 as analysts expect, RTX could generate 38% cumulative total returns through 2025. For perspective, that would be nearly triple the 14% cumulative total returns that are expected from the SPDR® S&P 500 ETF Trust (SPY) over that time. This is why, even with the P&W overhang and uncertainty, I am comfortable rating shares of RTX Corporation a buy right now.

Hi, my name is Kody. Aside from my five to six weekly articles here on Seeking Alpha, I am also a contributor to Dividend Kings and iREIT on Alpha. I have been investing since September 2017 and interested in dividend investing since about 2009.Since July 2018, I have ran Kody's Dividends. This is a blog that is documenting my journey towards financial independence using dividend growth investing as the means to transform the dream of financial independence into a reality. It's also the inspiration of my pseudonym here on Seeking Alpha.By God's grace, I owe everything to my blog for introducing me to the Seeking Alpha community as an analyst. That's my story and I hope you enjoy my work examining dividend growth stocks and the occasional growth stock!