Households and corporations may tighten their belts during periods of economic uncertainty, but you know who likely won't? The U.S. government, asserts Sean Brodrick, growth stock expert and editor of Wealth Megatrends.
It's no secret that geopolitical conflicts are worsening. With Russia and Ukraine at war and China upping its aggression over claims of Taiwan and the South China Sea, I expect countries to increase military spending worldwide.
Raytheon Technologies (RTX) is the largest U.S. defense contractor by market capitalization and the third-largest by government contract volume. It operates through its four main subsidiaries: Intelligence & Space, Missiles & Defense, Collins Aerospace and Pratt & Whitney. It merged with United Technologies in April 2020.
In FY 2021, 32% of Raytheon's revenues came from defense contracts, logging $20.7 billion in obligations. The steady flow of government contracts decreases its revenue sensitivity and makes it a safer bet in the event of a recession.
A worsening economic outlook could hurt Raytheon's commercial business, but the company has a massive $65 billion defense backlog to prioritize if it comes to it. When conflicts in Ukraine broke out, the company recognized it could take advantage. The Javelin missile is one of the bigger reasons why.
Raytheon produces the Javelin missile through a joint venture with Lockheed Martin (LMT). The U.S. has already provided over 8,500 missile systems to Ukraine. They cost $240,000 per unit, which equates to over $2 billion in aid from Javelins alone! That's not considering other requests and commitments for Stinger missiles, Tomahawk cruise missiles, jammers and more.
Strong Financials & Fundamentals
Raytheon has a consistent track record of beating earnings consensus, positively surprising estimates in each of the last 22 quarters. Analysts are projecting 16%–19% earnings growth over the next two years. Its annual revenues are anticipated to jump 5% this year to $67.6 billion and 30% to $83.6 billion by 2026.
After Raytheon's Q2 earnings announcement, it held $4.8 billion in cash and $10.4 billion in short-term receivables. It generated earnings before interest, taxes, depreciation and amortization of $2.4 billion and free cash flow of $807 million. Raytheon's strong financial profile and market capitalization of $122 billion give it additional flexibility.
The company does have significant debt, totaling $32.8 billion, but its debt to total capital ratio stands at an easily manageable 32%. Over 99% of its debt is long term, so it doesn't have any meaningful short-term commitments.
RTX is undervalued both historically and compared to its peers. The stock's price-to-earnings ratio of 17.3x is nowhere near its normal P/E ratio of 27.5x over the past 10 years, and it's well below the peer median of 20.9x.
Attractive Shareholder Returns
Raytheon is committed to rewarding shareholders through its healthy dividend and consistent share buybacks. Raytheon has increased its dividend in each of the last 28 years. RTX's payout ratio is a sustainable 45%, so it has plenty of room to continue increasing it.
Raytheon approved a $5 billion share repurchase program in 2020, and it replaced that initiative last December with a $6 billion share repurchase plan.
In Raytheon's Q2 2022 earnings announcement, the company confirmed it spent over $1 billion in buybacks during the quarter. RTX further committed at least $2.5 billion towards share repurchases this year.
RTX is significantly outperforming the broader market year to date, losing just 5% compared to the S&P 500's 24% drawdown. With strong positive tailwinds and rapidly escalating geopolitical conflicts, I expect it to continue outperforming.
Raytheon could face temporary weakness if the broader market continues struggling but it should see a bounce off support at about $81 per share. The defense contractor is trading well off its March highs, offering the opportunity to enter at bargain basement prices.