FA Alpha Daily

Manufacturing is coming home, bringing customers of this semiconductor supplier closer

Keeping the military trade open and flowing is necessary for the U.S. economy to stay on top. Raytheon Technologies Corporation (RTX) is at the forefront of this trade as it provides defense weapons and technology. In today’s FA Alpha, let us see how RTX will thrive in supplying the biggest defense spender in the world and its allies.

FA Alpha Daily:
Thursday Uniform accounting analysis
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There are many indicators showing how the U.S. will still be the dominant economic power for the next 80 years.

U.S. share of the world economy is booming. American companies generate more economic earnings than the rest of the world, resulting in a lot more tax collected by the government.

In fact, the tax revenue of the U.S. government was 25% of the world’s total tax revenue.

The tax can be used to deploy capital where it is needed to fuel growth and maintain economic stability.

However, the Pax Americana thesis does not just show that the U.S. is going to be at the top, but also how we are going to do it.

A big part of this is staying at the center of our military alliances, keeping the trade open and flowing.

We will keep supplying defense weapons and technology to our allies, and our companies will continue to benefit from it.

One of these companies is Raytheon Technologies Corporation (RTX).

The aerospace and defense company provides solutions and aftermarket services for commercial and military aircraft manufacturers.

It also develops integrated space, communication, and sensor systems, as well as air and missile defense systems.

In a period when the world needs more means to defend itself, Raytheon is destined to thrive.

However, looking at the as-reported metrics might confuse investors. The as-reported return on assets (“ROA”) dropped from above 5% in 2017 to 1% in 2020, before jumping to just below 3% in 2021.

According to these numbers, the company is not even generating returns at the cost of capital.

It is natural that the investors are puzzled, as Raytheon does not look like it is making any money by supplying the biggest defense spender in the world and its allies.

However, this picture of the company’s profitability is inaccurate. This is because of the disruptions in as-reported accounting and can be fixed by making the over 130 adjustments needed under Uniform Accounting.

When the numbers are cleaned up, we see that the Uniform ROA of the business was constantly between 10% and 12% between 2017 and 2020, before jumping to 13% levels in 2021.

The defense contractor is much more profitable than the as-reported numbers suggest and had a stable business over the last five years.

As the market grows and the world needs more defense systems, Raytheon will be one of the biggest winners in space.

Uniform Accounting allows us to see the real profitability of the business and make a better forecast of what it can do in the future.

SUMMARY and Raytheon Technologies CorporationTearsheet

As the Uniform Accounting tearsheet for Raytheon Technologies Corporation (RTX:USA) highlights, the Uniform P/E trades at 17.8x, which is around the corporate average of 18.4x but below  its historical P/E of 21.0x.

Moderate P/Es require moderate EPS growth to sustain them. In the case of Raytheon Technologies, the company has recently shown a 21% growth in Uniform EPS.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Raytheon Technologies’ Wall Street analyst-driven forecast is a 21% and 11% EPS growth in 2022 and 2023, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Raytheon Technologies’ $101 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 1% annually over the next three years. What Wall Street analysts expect for Raytheon Technologies’ earnings growth is above what the current stock market valuation requires in 2022 through 2023.

Furthermore, the company’s earning power in 2021 is 2x the long-run corporate average. Moreover, cash flows and cash on hand are 1.7x its total obligations—including debt maturities, capex maintenance, and dividends. Also, the company’s intrinsic credit risk is 50bps above the risk-free rate.

All in all, this signals low dividend risk.

Lastly, Raytheon Technologies’ Uniform earnings growth is in line with its peer averages but below its average peer valuations. 

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

The Uniform Accounting insights in today’s issue are the same ones that power some of our best stock picks and macro research, which can be found in our FA Alpha Daily newsletters.

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