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This Defense and Aerospace Stalwart Has Stumbled But Don't Count it Out

Motley Fool - Thu Feb 29, 5:38AM CST

RTX(NYSE: RTX) hasn't gotten much love from Wall Street lately. The defense and aerospace company is dealing with the fallout of an expensive Pratt and Whitney aircraft engine defect. Contaminated powder metal in an estimated 1,200 engines made between 2015 and 2021 could cause the engines to wear and crack over time.

The company took a $3 billion pre-tax earnings charge in September, and shop repairs could run RTX's total costs to $7 billion when all is said and done. It's a major blemish for a company that's performed well for decades, marked by 30 consecutive years of dividend growth.

RTX could take a few years to work through its issues, but don't miss the forest for the trees. The company's firm footing in the defense and aerospace fields makes the stock a potential buy for long-term investors willing to give management time to right this ship.

Here is what you need to know.

The business is fundamentally solid despite engine woes

RTX has gone through some changes in recent years. Formerly known as Raytheon Technologies, the company merged with United Technologies in 2020. After spinning off Otis and Carrier, RTX is now focused on products and technology systems for aerospace, defense, and space applications.

Financially speaking, investors have two concerns -- the dividend and how the engine defect may impact RTX's financials. The company is a dedicated dividend payer that has raised its distributions for 30 consecutive years. The stock yields 2.6% today, so it offers both good starting yield and the expectation of consistent payout growth -- a solid combination.

The dividend payout ratio is manageable at 68% of cash flow, so RTX can maintain its dividend while juggling other financial obligations such as the Pratt and Whitney damages, repurchasing shares, or paying down debt.

Secondly, RTX is positioned to absorb the costs of its engine defects. It already has $6.5 billion in cash on its balance sheet. On the other hand, the company's $44 billion in long-term debt isn't great. However, based on EBITDA (earnings before interest, taxes, depreciation, and amortization) estimates of $13 billion this year, it has a debt-to-EBITDA ratio of 3.3 -- an uncomfortable but manageable amount of leverage. Investors should look for management to focus on paying down debt over time.

Is earnings growth getting ready for takeoff?

Too much debt can be a disaster for a company if it lacks a clear path to dig itself out of that hole. Fortunately for RTX, the business is growing enough that investors can feel optimistic about its ability to tighten its finances over time.

RTX grew organic sales by 11% in 2023, including 23% growth in commercial aftermarket and 20% in original equipment. Sales for defense only grew by 4%, but the unit posted a 1.24 book-to-bill ratio, indicating that its revenue growth should accelerate in the future.

Management is guiding for 2024 performance, including:

Metric2024 Guidance (Midpoint of Range)YOY Change
Revenue$78.5 billion5.6%
Earnings per share$5.325.1%
Free cash flow$5.7 billion3.6%

Data source: RTX. YOY = year over year.

The numbers above are non-GAAP, and adjusted to strip out the impact of the Pratt and Whitney problems and give investors a better view of the performance of RTX's businesses.

Analysts estimate the company will grow earnings by an average of 10.2% annually over the next three to five years, so investors should look for a notable uptick in growth during the latter half of the decade.

A bargain blue-chip stock

When the Pratt and Whitney problems came to light over the summer, the share price plummeted. You can see that the stock's P/E ratio has bounced off its low, but remains notably below where it was trading before.

RTX PE Ratio (Forward) Chart

RTX PE Ratio (Forward) data by YCharts.

If you apply the long-term growth rate of just over 10% (analyst consensus), the resulting PEG ratio of 1.6 signals the stock is reasonably priced for its expected growth. Assuming the stock's valuation doesn't collapse from here, investors could see long-term annual returns between 10% and 13% once you factor in the dividend.

Let a stock compound at a double-digit percentage growth rate for a decade or longer, and you'll probably be very happy with the result. That makes RTX a no-brainer addition to any long-term stock portfolio.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool recommends RTX. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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