Raytheon Technologies Corporation (NYSE:RTX) Baird 52nd Annual Global Industrial Conference 2022 November 8, 2022 9:30 AM ET
Company Participants
Neil Mitchill – Executive Vice President and Chief Financial Officer
Conference Call Participants
Peter Arment – Baird
Peter Arment
Thanks, everyone. Good morning. My name is Peter Arment, the Senior Aerospace Defense Analyst here at Baird. We are delighted to have with us Raytheon Technologies this morning. And from Raytheon, we have Neil Mitchill, as Executive Vice President and Chief Financial Officer, long-time executive and before that many, many years the lead partner at PwC before joining Raytheon, our UTC parentage. So again, thank you, Neil, for coming.
Neil Mitchill
It’s great to be here.
Peter Arment
And I know Neil is going to make a quick opening forward-looking statement, and then we’ll go from there.
Neil Mitchill
Sure. Thanks, Peter. Great to be here. Nice to be in person in Chicago. I just need to warn you all that I might make some forward-looking statements today, and you should consult our 10-K and other recent SEC filings before taking everything I say at face value. However, you’ll see a description of the risks and uncertainties in those documents.
Maybe Peter, just a minute or two on the company. I think most of you know us, but Raytheon Technologies has four large segments: Pratt & Whitney, Collins Aerospace, Raytheon Missiles & Defense and the Raytheon Intelligence & Space segments. We’re leaders in the aerospace and defense sector across all four of those businesses.
In 2021, we had sales of $64.4 billion. And in 2022, we expect the sales to grow between 5% and 6% organically to $67 billion to $67.3 billion, so good strong growth there. And as you all know, most of that being driven by our commercial aerospace businesses this year where aftermarket was up year-to-date, almost 30% and the OE is also up nearly 20%, 17% so far in the first nine months. So the company is doing well.
We expect adjusted earnings per share of $4.70 to $4.80. We tightened that range on our earnings call a few weeks ago, and free cash flow of about $4 billion for the full year and share buybacks of at least $2.5 billion or $2.4 billion through the third quarter. So I think doing pretty well, obviously, encountering some supply chain and labor disruptions that have been well discussed and I’m sure we will get into that. But future is right for Raytheon Technologies. Why don’t we go to the questions, Peter.
Question-and-Answer Session
Q – Peter Arment
No, no problem. I appreciate that. Look, thanks for coming. And what’s great about — Raytheon, it’s just — you’ve got outsized both commercial businesses and defense businesses. So maybe let’s just start with the macro because I think that’s really important to kind of to set things off, and we could be heading into an environment where you’ve got this very elevated defense spending, and we’ve got a continued recovery in commercial aerospace. So maybe just give us your thoughts on both defense and aerospace on the just kind of how you think about it over maybe a multiyear to kind of think about it from that perspective?
Neil Mitchill
Yes, sure. So when I started the year and we were talking about our outlook, I was a little concerned about the assumptions we are making in the commercial aerospace recovery. And I will tell you that as the year has progressed, we’re pretty much dead on the assumptions that we laid out at the beginning of the year. So really strong recovery in commercial aero. And that’s despite, China sort of turning on and turning off, on and off. And I’m encouraged by the fact that they’re starting to talk about relaxing the zero COVID policy there. And I think that will be an important element of our growth going into 2023.
So I’d say on the commercial aerospace side, we continue to see a strong recovery. I think we’re about 75% of 2019 RPKs through the first nine months. We expect to exit the year closer to 90%. And I don’t see any change to that. And as we sit here, getting ready for our 2023 year, we expect continued growth. I think we’ll exit 2023 at or above 2019 levels. That will be, in my view, largely driven by the narrowbody recovery. That’s been obviously really strong. But we have seen international traffic up about 40% in the first nine months over the prior year. It’s slowly growing, and I think that will also start to take off.
So I’d say on the commercial aerospace side, clearly seeing the recovery of strong demand for narrowbody. I do expect OE rates, will continue to go up. So on the Airbus side, we’re working closely with them. We don’t dispute any of the demand signals for sure that are out there either in the near or long-term on narrow-body, and we’re aligned with Boeing as well on their rates and have that sort of baked into our rest of year and forward-looking assumptions as well. So I think on that front, more to come. And most of the growth that we’ll see next year is going to be driven by that continued commercial aero recovery.
Peter Arment
And you think that matches up kind of the commercial recovery piece. I think early on in the pandemic, you guys kind of said, maybe at the end of 2023, we’d kind of be back. That seems to be matching right now.
Neil Mitchill
Yes, absolutely. I think we’re seeing that right now. And when we get to 2024 that would be the first full year where we’re at or above 2019 levels. And that’s certainly — I think we’ll start more of that mid-single-digit type growth from there going forward. But right now, yes, I’d say that’s a track.
Peter Arment
Okay. And then just maybe flip over to defense, give that kind of multiyear how you’re viewing the elevated environment on defense when you think big picture.
Neil Mitchill
Yes. So the defense environment, clearly, since we spoke to investors back in May of 2021 has just gotten stronger, unfortunately, probably for the wrong reasons. But I think a good strong defense is really important for the NATO countries and our allies. We’ve seen a 1.15 book-to-bill on a nine-month basis in the defense businesses this year. And frankly, that’s before a lot of incremental bookings from the elevated environment that we’re seeing.
I think we expect to see about a 3% per year global modernization budget increases. We are certainly seeing a lot of proposal activity, and I expect us to see awards as we get into the latter part of this year and certainly into next year around Patriot, NASAMS, AMRAAM. We can go down the list. But GEM-T, for example.
Recently, just saw the national defense strategy get released, it’s really closely aligned to the Raytheon Technologies strategy and the product offerings we have. So whether it’s a layered defense, cyber space, the F-35 platform, we seem to be pretty well-aligned with everything that the United States and its allies are going to be prioritizing over the next three to five years.
Peter Arment
So organic growth kind of matching up to that.
Neil Mitchill
Yes. So we’ll see some growth in the defense businesses next year, but it’s not going to be what we would expected to be or what it could be. And that’s largely going to be driven by the continuation of material receipt and labor shortages that were — are more pronounced on the defense side.
They’re everywhere in our business, but I think show up pretty quickly in the defense businesses just given the accounting models that we use for revenue recognition. But that will, I think, temper the growth rates a little bit next year, but certainly, as you get into 2024 and 2025 and 2026, it will continue to grow.
Peter Arment
Terrific. Well, let’s not be shy and jump right into supply chain.
Neil Mitchill
My favorite topic.
Peter Arment
It’s been everyone’s favorite topic. So there’s been a lot of things, whether it’s castings and forgings or whether it’s parts availability of shops or whether it’s labor, take it where you want, but maybe you want to summarize how you kind of see that and hopefully abating as we get into next year and beyond?
Neil Mitchill
Yes, sure. So let me take you back to the beginning of the year. I think it’s important to talk about the evolution of some observations and thinking as the year unfolded. At the beginning of the year, when we thought about the supply chain issues and the softness that we saw in the first quarter, I’d say we really attributed that to COVID, and the spike that we were seeing at the end of the year and early into this year in Omicron.
As we got further through the first quarter and into the second quarter, it became obvious that it was more pervasive. It was a deeper issue. It was really labor-driven at our suppliers. About 46% of our suppliers would qualify for what we would call a small business.
So think about the stress that gets placed on a small supplier when you’ve got high rates of turnover in the labor. So that has continued to persist throughout the course of this year. And we don’t really see that fully recovering until we get through next year.
It’s certainly showing some signs of stabilization. When I look at material receipts on a weekly basis, we’re seeing improvement sequentially, steadily, but not significantly. So going in the right direction, but I think it’s going to take some time.
So that’s sort of the broad supply chain picture. As you kind of go around the horn on the top issues we’ve been talking about, castings continues to be a challenge. And it’s not just for our new OE deliveries, but also for supporting the aftermarket because our fleet is flying a lot, and growing as we deliver lot more GTFs, in particular.
And so it’s putting a lot of pressure in the supply chain on delivering castings at rate. I think we expect that to take the rest of this year and into probably through most of next year to stabilize and get back kind of to the levels where we need to see it.
But we’re certainly working with the casting suppliers to try to find alternative ways to test and qualify materials and help them get the parts out of their doors, so they can get them into our shops…
Peter Arment
Right.
Neil Mitchill
… both OE and MRO. So more to go on castings, but we are continuing to support our OE customers, as well as making the appropriate trade-offs between our aftermarket needs and delivering for new aircraft.
On rocket motors, another topic we’ve talked a lot about. That’s an issue that we also expect to continue through next year and frankly, into 2024 before that is resolved. I guess, on a bright note there, material seems to be flowing into the shops there, but it is a labor issue there as well.
And we’re working with that supplier to help them get more and more rocket motors into our shops to finish our products out. It’s one of the things that, goes on a missile later in the manufacturing process. So we’re able to keep some flow going to our factories, but it is a concern and a challenge, and I expect that to kind of persist through next year as well.
Semiconductors and microelectronics, another area, this is one where I’ve seen some stabilization. We’ve been able to work with the chip suppliers. We’re entering into some longer-term agreements. We’re getting a little bit better visibility to the flow of material coming into Collins and RIS and RMD, in particular.
We’re not out of the woods there, but I am encouraged by some of the dialogue that’s going on and some improved visibility we’re seeing in the parts that we need there. So I think that’s in a nutshell supply chain. It’s going to continue to persist through this year and into next year. We’ve got a lot of activity working with those suppliers.
It’s over 335 that we’ve got our own people on-site, working with the suppliers. We’re using predictive analytics and a whole bunch of other tools to make sure that we can look further down the horizon so that we’re ready for the growing rates of OE and aftermarket that we know are coming upon us.
And to deliver that defense backlog, which today is $67 billion. It’s up $3 billion just — since the beginning of the year. We’ve got almost $100 billion of commercial backlog. So it’s not for lack of demand. It really is going to come down to getting the right sequence, the signals into the supply chain, getting the supply chain healthy.
And we’ll see what happens with the global economy here, but perhaps we’ll see a little tightening of the labor markets and that might free up some folks that will help put a little relief into the labor shortages we’re seeing as well.
We’ve hired, I think, 27,000 people in the first nine months of the year. We need to hire another 10,000 people. A lot of those people, we need to hire with clearances to work on the projects that we have.
Peter Arment
What’s a normal attrition rate or…
Neil Mitchill
Pre-pandemic, we’d see high single digits. I mean, we’re double that in some areas, and our engineering is a high teen, 20% range ends on the business.
Peter Arment
Wow. Okay. Well, let’s go back to the aftermarket. You mentioned the aftermarket. Just your thoughts on kind of some of the key drivers going forward, I mean, obviously, recovering traffic, and we’re seeing it globally. And hopefully, China opening up at some point here a little more consistently should be helpful.
Maybe just give us your thoughts on kind of how you see aftermarket and maybe either if you want to bring in like cadence of shop visits, and how that kind of flows through?
Neil Mitchill
Yeah. Let me take you through a quarterly cadence on the shop business. I’m just kidding. So listen, we’ve had really good growth rates on the shop visits this year. I think we’re up about 16% on V2500 through the first nine months of the year, we still see that to be up about 20% this year.
That will continue to grow next year. I’m not going to put a number out there today, but do expect some pretty healthy growth on the Vs. Pratt Canada has seen their shop visits up in the 15% range. That’s about what we’ll see for the full year as well.
So good, healthy activity in the aftermarket there, again, we’re continuing to work with the supply chain to make sure we have all the parts to do those overhauls. We will see the GTF aftermarket start to pick up next year and the years after. So that’s a good news story for…
Peter Arment
Every year that increase, right?
Neil Mitchill
Yeah, that will just keep going up. As we add more and more aircraft in the fleet, the aftermarket will definitely start to grow there in a pretty measurable way, and the profitability will improve as well.
So I do expect the GTF aftermarket to be — in next year. So that’s good, and that will become accretive to Pratt & Whitney as we get into the 2024 timeframe, so, good news there, same thing at Collins.
I think provisioning year-to-date is up about 35% — I’m sorry, parts and a repair is up 35%. Provisioning is up 43% year-to-date. So we’ve seen a lot of activity as airlines are getting ready to get these fleets off the ground, and you see load factors at record highs.
And that’s all despite higher fuel prices. If anyone’s going to buy a commercial air ticket, they’re really expensive. And we haven’t seen the demand falling off there yet. So it’s a watch item, clearly.
If we were to go out a few years to make sure that the recessionary impacts don’t dampen travel, but there is so much pent-up demand. And we’re just not seeing any signals yet in our business that it’s going to slow down.
So I expect that growth to continue. As I said, I think in 2023, most of the revenue and profit growth we’re going to see at RTX is going to come from those commercial businesses in January if you have the quarterly profile.
Peter Arment
We don’t want to talk about 2323, but I’ll ask about 2025, because you guys put out your targets and just maybe how this is mapping to that. Maybe you could just update everyone on what those targets were. And I think that’s helpful just because it seems like you are tracking that way.
Neil Mitchill
Yeah. No, we are very confident that we can see line of sight to those 2025 targets. We’ll see robust sales growth. We got targeted at $10-plus billion of free cash flow. Back when we put those plans together, a couple of things have changed, but I think by and large, we’ll work our way to offset some of those things.
So Russia, obviously, was an unexpected headwind, but defense growth, I think, is a little bit stronger. Inflation is clearly stronger than we were thinking back then, but we’re working hundreds of projects to offset that, including raising our prices, some of which we’ve already implemented and some will come into effect at the turn of the year here.
So as I look over the horizon and through that, the projects that we’re starting, I’ve said this before, we’ve got a lot of projects that the paybacks are more attractive in this environment. So the list is getting longer. And I’m confident that we’ll be able to work back some of the cost growth that we’re seeing, entering into long-term agreements, working with suppliers that are not performing and making them be accountable so that we’re not paying a higher price for things that we’re not getting on time.
And so as I look at 2025, I think all the ingredients are there for hitting those targets, particularly the strength we’re seeing on the defense side is really, really helpful. And we’re right on the commercial recovery trend because I think that’s good. I think when I was asked that question 1.5 years ago, I thought the middle years were really blurry. It was hard to see through the recovery and everything. But certainly, as we get to 2025, I think we’ll be onshore footing there with the economy and the aerospace recovery.
Peter Arment
Terrific. So right now, I guess, the business is 55% defense roughly. How do you think that — does that change much through that period now with defense being a little more elevated? Do we — or do we end up with a 50/50, kind of, split when we get there?
Neil Mitchill
Yeah. It’s a good question. It probably shifts a little bit more towards aerospace, frankly, because we’re going to have so much growth on the aerospace top line I assume, is what you’re talking about given the OE deliveries over the next several years. So — but it will still be a pretty balanced portfolio across RTX, and I think it’ll be in that 60, 55 range, kind of, split.
Peter Arment
Yeah. Maybe just going back to just defense, missile defense, in particular, you’ve had a lot of success on the battlefield, unfortunately, but you’ve had a lot of success. Maybe you could just update us on some of the activity that you’ve seen, obviously, being used in Ukraine. How do we think about replenishment opportunities, and maybe just any discussions where you see just deterrence and they got to have some level of deterrent? So do we see NATO countries just stepping up their buys to put something in place regardless whether either using it or not?
Neil Mitchill
Yeah, great question. I mean, certainly, on the battlefield, we’ve seen the Stinger and the Javelin be very effective. Stinger is a very, very old weapon, and we have received additional orders for it, but there are some limitations because of the age of the technology, but we’re working with the US government and our allies to make sure we can ramp up our production levels to support that need. So definitely a plus there. We’ve also seen some…
Peter Arment
You’re restarting that line.
Neil Mitchill
We are. Yeah, we had one small international order, but we’re essentially restarting that line, but we have — that line is up and running, and we’ve been able to bring back some folks that worked that line, and have retired, but for the mission have come back to make sure that we can successfully meet the need of the Ukrainians. So that’s good.
And frankly, when you think about the orders that we received, it’s really just been Stingers and Javelin. We’ve had a little bit in NASAMS activity. I expect some more here in the fourth quarter. I won’t comment on what additional systems might go out there. But certainly, our NATO countries are looking at their ammunition stockpile. And just yesterday, you probably saw some headlines around multiyear buys there. And so that is something we’ve been advocating for. It’s really difficult to start up a cold line, especially when you need them. And I think that there are folks now making sure that as we look around the world and unfortunately, in the growing threat environment, we need to make sure that not only do we have these great platforms and airplanes, but we also have sufficient conditions and depth ammunitions to support an event if we have to contribute, we have to use these weapons.
Peter Arment
Yeah. So something that came up in discussion with another one of your competitors at a prime level is just that having a more sustained buy, so that you keep these lines warm, whether it’s — is that something you see coming out of all this?
Neil Mitchill
I’m encouraged, because I do believe that the government and the allies will see that as an opportunity to bring a little bit of certainty to the supply, but also will help the cost, because anytime we do a long-term run of a production run, we’re able to drive productivity and efficiencies there and pass some of that along to our customers as well.
So I think it makes sense from a lot of respects. Certainly, starting up these old cold lines is very, very challenging. It also allows us to do technology inserts throughout the life of these weapons when we have certainty of volumes. And I think that would bring a lot of clarity and certainty to our ability to go out on long-term agreements, would help with some of these supply chain issues, honestly.
Peter Arment
Yeah, sure. Maybe let’s talk about some of the new technology in defense, just some of the opportunities, maybe that you’re most excited about the next few years, whether it’s hypersonics or next-gen Interceptor, Patriot, wherever you want to take it.
Neil Mitchill
Yeah, I’m excited about a lot of the new technologies. Of course, unfortunately, I can’t tell you about much of them, but I’ll start with hypersonics. We are really thrilled to see the $1 billion HACM award. I think that’s tribute to the team’s efforts over a prolonged period of time to develop that technology, not just as a demonstrator, but as something that can be flown and produced. And so I believe that our position there is really strong.
As you pointed out, we’re also continuing to work on the HAWC program, the Glide phase interceptor. We do think that certainly defensive hypersonic weapons is really going to be where the majority of the dollars get spent. And I think a lot of the work we’ve done is translatable to those programs going forward. So I feel really confident there. And there’s other forms of systems that we’re looking at too, high energy laser, microwaves, I mean there’s a lot of different things that we’re working with the services on in a variety of ways that I’m pretty excited about, and I think they’ll make their way into products in the coming years.
And then the LTAMDS, the next-generation Patriot system. We’re working that program hard. We’ve got a number of units already produced, and we’re testing them and doing the software integration. So that is going to be a really exciting franchise for the company. It’s over $40 billion in life of program revenues to us. So I think when that comes out, call it, late 2024 into 2025 and 2026 as we ramp up production that will be a really transformational piece of equipment that we add in the R&D portal.
Peter Arment
Is that steady state finally like 2026? Is that the way to think about it?
Neil Mitchill
I would say it’s still ramping even in 2026, because we’ll start with predominantly deliveries to the US Army and then that will expand to foreign military sales as well. So it will grow, but there’s over 250 Patriot systems out there today. And I would expect many of the customers that are using future system are going to want the upgrade.
Peter Arment
Yeah, for sure. All right. Let’s move over to a margin expansion story that. And a lot of things post the merger, right? Synergy update. So I think your target was initially $1.5 billion. I think that’s a gross number. But maybe just give us your updates on where things are today and how things are tracking?
Neil Mitchill
Sure. We have a lot of initiatives underway and the $1.5 billion synergies from the merger is just one piece of it. But our initial target was actually $1 billion. And right out of the gate, we were able to up that to $1.5 billion. There’s probably a little bit more gas in the tank. We’re at about $1.3 billion year-to-date. For this year, we’ve realized incremental $275 million on our way to like $335 million for the year. So we’ll be pretty close to the $1.5 billion as we exit the year.
A lot of that came on the back of consolidating corporate functions and footprint consolidation, office of the future, as we call it, is a major piece of our savings opportunity. But that’s just stuff driven from the merger itself. Separate from that are literally billions of dollars of cost reduction activities that address the supply chain, and our footprint outside of the direct merger impacts.
There are hundreds of projects, Peter, that we’re working on to simplify our footprint, automate our facilities, to automate our inspection techniques, to improve our design and digitization of build, connect all of the equipment in our factories, almost 40% of Pratt & Whitney’s factory machineries are already connected.
Peter Arment
Right.
Neil Mitchill
And that kind of insight allows us to do predictive maintenance on equipment. We get signals from the equipment before it has a breakdown. So really powerful investments that we’re making. And we’re very close to opening up our Asheville Facility in North Carolina, in fact, I’ll be down there next week to do the ribbon cutting with the team.
Peter Arment
Perfect. Wow.
Neil Mitchill
So a lot of great progress. Obviously, investments have come along with that, and higher inflation eating away some of that good work. But I think we’ll be able to keep our head above water and outpace the inflationary cost as we do more and more of these projects in the future.
Peter Arment
Yes. I can just go back to Heritage UTC when they had Goodrich and those numbers were blown away. Rockwell Collins, they continued grow. So I just assume that at some point, you just stop reporting this, and it just gets built-in, right.
Neil Mitchill
I think so. We’ve got multiple work streams right now going on with cost reduction. At some point, we’ll just call it all one thing.
Peter Arment
Right.
Neil Mitchill
But certainly, we want to see it to fruition on the synergy side and then will merge it in with our typical and standard cost reduction activities that are underway every single day.
Peter Arment
So let’s talk capital deployment, remaining couple of minutes here. Give us your latest update and just thinking about also that, in this environment where there’s just a lot coming at you from defense requirements, commercial aerospace, just CapEx, how should we think about that versus — and then your thoughts on just additional share repo things —
Neil Mitchill
Sure. Yes. So let me start with the $20 billion commitment we made following the merger. So within four years following the merger, we’re still very committed to $20 billion of capital return, $12 billion or so will come in the form of dividends, as we’ve said. The rest will come in the form of share buyback.
We’re already at $12 billion, we’ll be a little north of $13 billion by the time we turn into 2023. Greg talked about some of the thinking for next year, share buyback in the $3 billion range, and we’ll continue to grow the dividend as the earnings grow.
So we’re laser-focused and committed to that level of return to capital. And of course, after we get past four years, there’s plentiful cash available for a continued path down that share buyback and dividend growth path. So no concerns there.
And you pointed out the capital, and that’s after we’re using about $3 billion of CapEx and $3 billion of R&D, so about $6 billion or so of our own money through the 2025 period, split somewhere in that 50/50 or 55/45 kind of a split to continue to invest in future technology for our customers and to drive structural cost out of the business, around automation and all the things I just talked about.
So we’re not starving the business, as I tell our leadership and investors here, we are making the right investments for the long term, because, as you know, these are 10, 20, 30-year franchises that we’re investing for.
Peter Arment
Right, right. All right. We have one minute left, so I’ll just ask the proverbial M&A question. Just — this is an administration that, there isn’t a lot of deals getting done in this industry, at least from a vertical integration perspective. Just maybe your thoughts on M&A going forward, whether it’s just — what’s the approach? And is there an appetite at all, just given that you have this enormous backlog really in both businesses?
Neil Mitchill
Yes. Well, we certainly like the portfolio that we have. So — and to your point about the administration, I don’t see us being able to do any major M&A and we’re not focused on that right now. We are always looking for bolt-on type M&A that would augment some of these exclusive technologies that we offer.
And so, we’ve got activity in that area, but that will be relatively modest over the next several years. Again, it’s not opportunistic unless something comes up. But right now, I’d call that relatively small $200 million, $300 million type of deals.
We’re always looking to review the portfolio, and so we’re continuing to do that. There could be some activity there, but nothing to report today. Couple of businesses that we’re focused on making sure we understand how they fit into our portfolio and whether that’s the best use of our capital, as it’s deployed there today. But nothing new to report and nothing major expected in the coming year.
Peter Arment
Terrific. Well, I know we’re right up at the end. So thank you, Neil. Thanks for joining us. And thank you. Have a great day. I appreciate it.
Neil Mitchill
Thanks, Peter.
Peter Arment
Thank you.
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