My Top Aerospace and Defense Stock to Buy Now

Raytheon Technologies(RTX 0.89%) second-quarter earnings weren’t perfect, and the company has work to do to meet its full-year guidance.

But there were enough positives to justify buying the stock for long-term investors. Here’s why it remains the pick of the aerospace and defense sector.

Raytheon Technologies’ second-quarter earnings

The headline news is that management maintained its full-year guidance:

  • Sales of $67.75 billion to $68.75 billion
  • Adjusted earnings per share (EPS) of $4.60 to $4.80
  • Free cash flow (FCF) of $6 billion

However, the headlines don’t always tell the whole story, and it’s a tale of two sectors for the company. In a nutshell, strength in its commercial aerospace-focused businesses (Collins Aerospace and Pratt & Whitney) is offsetting headwinds in its defense-focused business (Raytheon Intelligence & Space, or RIS, and Raytheon Missiles & Defense, or RMD). In fact, management lowered sales and earnings guidance for RIS and RMD while raising earnings guidance for Collins Aerospace and earnings and sales guidance at Pratt & Whitney.

Commercial aerospace flying high

The increase at Collins Aerospace comes down to a more favorable margin mix, given the strength in its higher-margin commercial aftermarket sales (up 25% in the second quarter).

Meanwhile, the sales and earnings guidance increase at Pratt & Whitney comes down to two factors: A robust commercial aftermarket (up 26% in the second quarter), and what CFO Neil Mitchill described on the earnings call as a “better commercial” original equipment mix. CEO Greg Hayes said Pratt & Whitney was running behind on geared turbofan (GTF) engines (used on the Airbus A320neo family and other aircraft). The GTF is probably still sold with negative margins, so the segment’s margin is likely to receive a boost due to lower-than-expected GTF deliveries.

The outlook for commercial aerospace remains highly positive, barring a sharp recession. Leading airlines report favorable conditions, and can pass on costs to customers due to surging demand.

Defense issues

Raytheon’s strengthening commercial aerospace market is a reason to buy the stock, but investors and analysts will be concerned, at least in the near term, about the outlook for RIS and RMD.

Both the defense-focused businesses have been inordinately hit by supply chain pressures and a lack of availability of materials such as titanium structural castings. Hayes discussed the issues on the earnings call, stating that Raytheon’s commercial aerospace businesses had 80% of suppliers on long-term agreements (LTAs), which means the suppliers should hold buffer stock in place. However, only 10% of RIS and RMD suppliers are on LTAs, so they’re more exposed to near-term supply chain issues.

Hayes went on to say that the defense businesses typically aim to provide 90% to 95% of “kits to the shop floor to assemble.” However, in the second quarter, “we saw kit fill rates around 50%.” He then described Raytheon’s aim of getting to 80% by the end of the year as “a big get.”

At this point, investors might ask how Raytheon will meet its full-year guidance for RIS sales to only decline “mid-single to low single digits” and RMD sales to increase slightly. For reference, RIS sales declined 5.6% in the first half, and RMD sales fell 8.9%. So the RMD guidance, in particular, looks like a big ask.

Why Raytheon Technologies is still a buy

Even though the company faces the challenge of meeting its full-year defense guidance, the commercial aerospace business is tracking ahead of original plans. Moreover, it’s important not to get caught up in a couple of trading quarters. Raytheon may well miss expectations on defense over the next six months, but the overall defense spending environment is improving.

That means any lost 2022 revenue would likely be pushed out. For example, the conflict in Ukraine has strengthened many countries’ defense spending commitments, and Hayes noted that defense committees are recommending spending increases on Raytheon defense products. Meanwhile, Raytheon’s defense backlog now stands at $65 billion, up $2 billion from the start of the year.

Raytheon is an attractive stock for aerospace and defense investors who can tolerate some near-term risk around its earnings in 2022.

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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