By Michael Elkins
Jefferies downgraded Raytheon Technologies (NYSE:RTX) to a Hold rating (from Buy) and cut their price target on the stock to $110.00 (from $115.00) in the face of near-term profit headwinds, lack of visibility, and a steep FCF ramp reliant on op income growth.
Analysts wrote in a note, “With Collins' story well appreciated and rather solid (30% of sales/50% of segment EPS growth), we believe the biggest questions are Defense (40% of sales/25% of EPS growth) and Pratt (30% of sales/25% EPS growth). Given budget trends, Defense revs grow at a 5% CAGR in '22-'25 w/ margins up 180 bps (Ex 15). Every 50 bps of Defense margin = $0.10 to our 2025 EPS base of $6.40. At Pratt, GTF AM is biggest EBIT driver of the segment's expansion from $1.1BB in 2022 to $2.2BB in 2025. We est GTF revs grow from $1.3BB in 2022 to $3BB by 2025 (Ex 10). Assuming 40% drop-through, this is $650MM of the incremental $1.1BB of EBIT growth at P&W. Every $100MM of EBIT is worth $0.06 to EPS; put differently, every 100 bps of P&W margin is worth $0.15. If we assume 1 of 2 of the above do not improve (P&W or Defense), this could drive EPS down to ~$6.25 in 2025 vs cons of $6.78. At a market multiple of 16X, this derives $100/sh.”
Jefferies values the GTF program at $5/sh, but notes that each 200 bps of AM margin downside from a 30% baseline in '26 is worth $0.80/sh. At the run rate, each 500 bps change in the GTF AM margin is worth $0.06 of EPS.
With the RMD and RIS combination, RTX creates a single $29 billion defense segment vs $11B avg segments at the primes, which removes critical clarity from the growth profile. Raytheon has relatively underperformed with sales -3% organic in '22 and margins down 170 bps vs peers +1% and -10 bps.
Jefferies estimates that RTX generates $7.1B of FCF in '25 (consensus $8.2B). From the $4.9B base in 2022, FCF is driven by $3.2B of EBIT growth offset by a $1.3BB CAS pension headwind.
Jefferies sees risk to the 2025 updated FCF target of $9B, which represents a steep ramp from ~$4.8B expected for 2023 and is largely predicated on growing the bottom line with likely headwinds around working capital and Pratt profitability.
With the defense ramp and commercial OE ramp largely baked in, Jefferies sees limited near-term catalysts, with the current FY2 consensus FCF yield of 4.5% limiting rerating potential.
Shares of RTX are down 1.38% in afternoon trading on Thursday.