Investors seeking value should notice the bearish trading action following Raytheon’s (RTX) earnings and revenue beat in the second quarter. Boeing’s (BA) underperformance might explain the pull on the aerospace and defence player. But Raytheon pays a dividend that yields 3.3% and trades at a forward price-to-earnings of 15.37 times.
Are investors too cautious on Raytheon following its massive merger of equals with United Technologies that closed on April 3, 2020?
Markets are justifiably fearful of companies that have grown in size at a time when the coronavirus pandemic is gripping the world economies. AT&T (T) offers a solid 7.02% yield and is a DIY dividend income champ on my marketplace. The company said it would raise its payout ratio from 50% to 60% if needed. CEO John Stankey said, “We remain committed to our dividend, which we’ve increased by 36 consecutive years. We finished the quarter with a dividend payout ratio of about 50%. We expect to end the year with our payout ratio in the 60s, likely at the low end of that range.”
AbbVie’s (ABBV) completed its acquisition of Allergan in May 2020. It forecast “full-year adjusted earnings per share between $10.35 and $10.45 including $0.70 of accretion from the Allergan transaction which represents an annualized contribution of 11%.”
Investors may infer from these examples that Raytheon will extract higher profit margins from cost savings from the merger. It will also offset the 53% drop in commercial OEM sales with military sales, which were up 11% Y/Y in the second quarter.
Raytheon earned 40 cents (non-GAAP) a share but posted a GAAP EPS loss of $2.56. Revenue grew 26% Y/Y to $14.28 billion. The impairment of Collins Aerospace’s goodwill and intangibles cost it $2.13 a share. Another 28 cents in EPS was due to acquisition accounting adjustments related to intangible amortization. It wrote off 21 cents in EPS for restructuring.
Backlog topped $158.7 billion. A record $73.1 billion of that was from the defense segment.
In the quarter, the U.S. Air Force selected the firm to develop the Long-Range Standoff Weapon (“LRSO”). It booked $2.3 billion for TPY-2 Radars ordered by the Kingdom of Saudi Arabia.
Sales at Collins Aerospace fell 35% Y/Y. Operating profits underperformed due to lower sales and COVID-19-related costs. Similarly, Pratt & Whitney sales fell 30% (adjusted), hurt by commercial OEM down 42% and commercial aftermarket down 51%. In both segments, favorable military volume and cost mitigation strategies ahead will reverse the underperformance in the coming quarters.
Identifying $2 billion in cost cuts this year and $4 billion in cash conservation will strengthen the company’s liquidity. In Q2, RTX realized $600 million, or 30%, in savings. This is better than expected. The company will realize 30% of its cost actions in Q3 and around 40% in Q4.
Investors may take advantage of the year-to-date decline of 35% in shares of Raytheon. As it realizes merger synergies, grows its defense sales, and realizes strong revenue from its military program, shareholder returns will rise. The company is committed to returning $18 billion to $420 billion of cash to shareholders in the first four years post merger. This is despite the government’s uncertain spending climate.
The markets are acting as though the U.S. government will cut its budget. So far, the development of LRSO for the U.S. Air Force will have a lifetime value of over $10 billion. Raytheon Intelligence & Space (“RIS”) booked over $1.4 billion of classified bookings in Q2. It also has a Global Aircrew Strategic Network Terminal program worth $166 million with the U.S. Air Force.
Raytheon’s fair value is $81.45, 42% above the recent close:
(Data courtesy of Stockrover)
Wall Street analysts have a similar price target, which averages around $74.00 (per TipRanks). The stock has a high score on value and growth. The market sentiment is 14/100 because of the stock’s sharp drop from a pre-COVID-19 high of over $90 in February 2020. Even though shares bounced back by June to almost $75, the stock is on a downtrend again.
Seasonal weakness from May through September suggests Raytheon shares could head lower to $50-55. By January 2021, after the U.S. presidential elections, the stock could soar:
(Data compiled by Stockrover)
Raytheon scores an A+ in profitability:
(Data courtesy of SA Premium)
The D+ score for low net income margin may change as the merger unfolds. Realized cost efficiencies will more than offset the declining revenue in the underperforming units. This will lift the company’s net income margin.
Raytheon’s merger is weighing on the stock’s performance. By contrast, Lockheed Martin (LMT) is in a steady trading range, such that its investors are not losing money. It also pays a 2.55% dividend yield. Patient investors willing to bet that management will increase margins in the next four years should buy RTX stock instead. When growth accelerates, the stock will bounce back.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RTX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.