I updated investors in a pre-earnings article suggesting that RTX had been consolidating constructively since June 2023. However, the surprising announcement by management on reducing its free cash flow or FCF guidance for FY23 caught the market unprepared. As such, the market needed to de-risk RTX Corporation’s operating results in the second half.
Keen investors should recall that the leading aerospace company stressed issues linked to a “rare condition in powder metal” linked to some of its Pratt & Whitney engines. It’s expected to “impact a significant portion of the PW1100G-JM engine fleet” but not the current production processes.
The company stressed that about 200 engines are expected to be removed for “enhanced inspection” by mid-September. However, RTX anticipates a further inspection of about 1000 engines over the next nine to 12 months. As such, the company emphasized that investors should have better clarity when announcing its third-quarter earnings release.
As such, I believe it’s justified that the $500M reduction in FCF guidance is likely reflected in the post-earnings selloff. However, despite the massive battering, the lack of aggressive buying sentiments suggests market operators have placed RTX in the “penalty box.” Investors are likely assessing whether RTX Corporation’s FY24 FCF guidance could be impacted. While RTX doesn’t anticipate 2025’s outlook to be affected, it didn’t provide the clarity analysts were looking for on its July earnings call. As such, I believe buyers who accumulated more positions at its July hammering are likely confident that RTX would sort it out expeditiously.
Are these buyers overconfident? I don’t think so. Notably, RTX’s valuation has normalized and is no longer overvalued. Accordingly, RTX last traded at a forward EBITDA multiple of 11.4x, in line with its 10Y average of 11.3x. Furthermore, the wide moat aerospace company also traded in line with its peers’ median, suggesting the market has reflected substantial execution risks. Furthermore, leading rival General Electric (GE) stock’s relative outperformance has widened its valuation gap with RTX, as GE last traded at a forward EBITDA multiple of 16.2x.
As such, I believe a subsequent rotation back into RTX seems likely if the company demonstrates that such pessimism has been overstated as it works to resolve the manufacturing quality headwinds.
Furthermore, I believe it’s clear that buyers didn’t allow the critical $80 support zone to be breached decisively at RTX’s July 2023 re-test.
Although buying sentiments are assessed to remain cautious, the support level remains valid, predicated against September 2022’s bear trap (false downside breakdown) price action, which saw robust buying sentiments.
Therefore, I urge investors to remain patient, using the recent pessimism to add exposure and average down accordingly. Near-term catalysts are likely lacking until the company resolves its engine inspections and provides better FCF clarity. However, high-conviction investors have been afforded another solid opportunity to buy RTX’s significant dip, particularly if they missed adding aggressively in September 2022.
Rating: Maintain Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
We Want To Hear From You
Have constructive commentary to improve our thesis? Spotted a critical gap in our view? Saw something important that we didn’t? Agree or disagree? Comment below with the aim of helping everyone in the community to learn better!