RTX Corp. (RTX, Financial), the former Raytheon Technologies, has taken a tumble over the past couple of months. Since reporting second-quarter earnings on July 25, RTX has seen its stock drop nearly 18%.
That decline has come despite the aerospace company having surpassed analysts’ earnings expectations. This post-earnings move may seem a bit surprising at first glance at least, since stocks tend to rally on news of a significant earnings beat. When they fail to do so, it means something else is probably going on. Such is the case with RTX.
Earnings beat
As I have discussed previously, things seemed to be looking pretty good overall for RTX when it released its earnings for the second quarter, having outperformed analysts’ expectations on both top and bottom lines. Revenue grew 12% year over year to $18.3 billion, comfortably above the consensus estimate of $17.7 billion. Earnings grew at a comparable pace, up 11% over the same period, with actual earnings per share of $1.29 compared to the analyst consensus estimate of $1.18.
Engine recall
Unfortunately, all of the apparent good news was ultimately overshadowed by the revelation that Pratt & Whitney, one of RTX’s three operating divisions, had suffered a significant setback. Specifically, inspections had uncovered microscopic cracks in Pratt & Whitney’s Geared Turbofan (GTF) engines, which apparently were the result of a rare defect in the powdered metal used to make their high-pressure turbine disks. RTX CEO Greg Hayes addressed the expected financial impact of the GTF engine problem in the company’s second-quarter earnings press release on July 25:
“Based on the strong performance year-to-date and strong endmarkets, we are raising our full year sales outlook and tightening our adjusted EPS outlook. However, we are lowering our free cash flow outlook to reflect the impact of an issue that has recently come to light, which will require Pratt & Whitney to remove certain engines from service for inspection earlier than expected.”
The extent of the recall was made clear the very next day when Pratt & Whitney announced the recall of nearly 1,200 of the 3,000 GTF engines currently in service for detailed inspection.
Cash flow impact
The GTF engine recall has already had a material impact on RTX’s cash flow, causing its second-quarter cash flow to fall short of the analyst consensus. However, the impact is almost certain to continue for some time. The company has in recent weeks sought to better quantify the impact of the GTF engine debacle. On Sept. 11, the company issued a press release with updated estimates of the financial impact. It read:
“As a result of recent updates to this matter, RTX will recognize a third quarter charge which will impact reported sales and earnings for the year…Approximately 600 to 700 engines will be removed for shop visits between 2023 and 2026 beyond Pratt & Whitney’s shop visit forecast entering 2023. A majority of the incremental engine removals required by the fleet management plan will occur in 2023 and early 2024...RTX pre-tax operating profit impact is estimated to be between $3 billion and $3.5 billion over the next several years, inclusive of an approximately $3 billion pre-tax charge in Q3, after partners’ share of charges.”
While RTX expects to take a hit, especially during the third quarter, the damage appears to be manageable. Indeed, the company reiterated its July earnings and cash flow forecast, guiding for earnings of $4.95 to $5.05 per share and free cash flow of $4.3 billion.
Final thoughts
Several aerospace analysts have chimed in about the recall’s likely impact on RTX, such as Mike Zaccardi, who highlighted a number of potential setbacks and risks in a Sept. 11 research note:
“Free cash flow may suffer, and earnings will likely be hit before long. The troubles also hinder inventory that must now be diverted to address the GTF issues, which may also lead to a cash drain over the coming years…Key risks include a downturn in the global aviation cycle and reduced government investment in aerospace assets. A broader slowdown would undoubtedly hurt the business given that nearly half of RTX’s sales come from non-US markets.”
While the GTF issue has undoubtedly created a serious risk overhang that is unlikely to disappear anytime soon, RTX currently appears to have the problem largely under control. Indeed, management remains confident in its earnings guidance and has even confirmed that its $3 billion stock buyback program will remain intact despite the recent setbacks. These signs of confidence have failed to assuage the market thus far, but that could well change in the coming months if the company can deliver on its promises.
Investors looking at this name should remain attentive to new developments in the GTF engine story, as it will likely be a key driver of market sentiment for the foreseeable future.
