RTX Corp

Second-quarter revenue grew 14% year on year to nearly $25 billion, with double-digit increases in aftermarket engine sales, original aircraft equipment deliveries, and missile-related sales. Adjusted segment profit rose 18% in the quarter, with margin expansion in each of the company's franchises.

Why it matters: RTX delivered another impressive result, with sales exceeding our forecast by a combined $2 billion and all three of the firm's franchises expanding their adjusted operating margins by at least 30 basis points. Pratt & Whitney's aftermarket revenue outstripped our forecast and continued a trend of double-digit expansion in that franchise, driven by high global aircraft utilization, especially among older jets as airlines await delayed newer models due to ongoing supply chain backups. A spike in demand for missile systems from the US and allied militaries is rolling through Raytheon's accounts as the company increases output capacity in preparation for new multiyear purchase agreements.

The bottom line: We've increased our fair value estimate for wide-moat RTX's shares to $214 from $200, reflecting some time value of money as well as a bump upward in our near-term forecasts.

Our $214 fair value estimate implies a price/2026 estimated earnings multiple of 29.7 times and an enterprise value/2026 adjusted EBITDA multiple of 17.8 times.

We see the most reliable drivers of profit growth at RTX coming from its large commercial businesses Collins and Pratt & Whitney. In both segments, aftermarket parts and service should provide many years of profitable and recurring revenue as overall demand for air travel grows. Pratt & Whitney's commercial segment has survived substantial headwinds resulting from the covid-19 pandemic. It is absorbing more than $3 billion of costs to replace high-pressure turbine and compressor disks in hundreds of its engines due to a metallurgical flaw, but we expect 2026 commercial sales at the business to be 72% higher than in 2019 due to ramping up deliveries of its GTF engine to Airbus and robust aftermarket activity on the previous generation V2500. Collins' commercial exposure has a significant component placement on the Boeing 737 MAX and continues to work through coronavirus aftereffects on the supply chain, but postpandemic demand brought Collins' top line to surpass 2019 levels in 2023, and we expect it to grow nearly 7% annualized over the next five years.

We're anticipating the firm's military revenue will grow at a 5.8% CAGR over our forecast period. On a segment-by-segment basis, the driving force behind that growth is F135 engine production in Pratt, aggregate US military spending in Collins, and increased emphasis on missiles, missile defense, and the militarization of space for Raytheon.

We also forecast continued margin expansion over the short and medium term, with operating margins normalizing north of 13%. The business we expect to deliver the highest absolute operating margin in our forecast, at 17.7% adjusted operating margin and accounting for over one third of consolidated operating profit, is Collins, where numerous projects are underway to consolidate back office and engineering systems, processes, technology, and the like to deliver cost savings over the long term. We see additional margin expansion potential at Pratt & Whitney, which we anticipate will benefit from both reduced negative margin on new commercial engine sales over time, as well as mix shift toward higher-margin service revenue.

We aren't anticipating major changes to the proportion of revenue that RTX will need to invest in capital spending over the long term and will normalize around 3% of sales in subsequent years. Pratt & Whitney will need to continue to reinvest in the business to ramp up the GTF engine production, and the legacy Raytheon business will need to continue increasing production capabilities.

We think an 8% weighted average cost of capital, somewhat higher than other defense primes, is justified for this business due to its exposure to commercial aerospace.

Each of RTX's three segments—Collins Aerospace, Pratt & Whitney, and Raytheon—deserves its own wide moat.

Broadly speaking, the aerospace and defense industry is characterized by substantial upfront development costs to create a net present value positive program that usually pays out over decades. Suppliers of aerospace systems tend to recoup the development cost of their products over many years of servicing them with specialized parts and engineering to meet their originally certified specifications. Defense contractors often share the upfront development costs with the government, and once awarded the contract to produce a given item, also share some ongoing costs, such as pension provisions, with the customer. RTX's business portfolio, the result of a bold series of corporate mergers and spinoffs in 2018 and 2019, fits well into these frameworks. The relevant moat sources for each of these segments are intangible assets stemming from the substantial accumulated engineering know-how required to enter the market, creating a stiff barrier to entry for external firms as well as deeply entrenched customer relationships and switching costs originating from a razor-and-blade business model in its aerospace segments, component placement in products with decades-long cycles in all segments, and switching costs stemming from mission criticality and lack of viable alternatives.

We assign Collins a wide moat based on intangible assets and switching costs. We see the moatiest parts of this segment as difficult-to-replicate, highly integrated, mission-critical products such as avionics, landing gear, sensors, and flight controls. Historically, component providers have had roughly 15%-20% margins on the product, which is about double the roughly 10% margins of their main customers, the aircraft manufacturers.

We think the primary moat source in this segment is switching costs because these products are deeply integrated into the functions of an aircraft, which are long-cycle products. Changing suppliers for mission-critical components for an already certified aircraft can be risky and difficult. Switching would require substantial effort in redesigning the aircraft to accommodate the new product, production delays for recertification, updated maintenance procedures, and (since many nonengine components of aircraft are not a big portion of the cost of a multi-million-dollar aircraft) would not render material cost savings relative to the aircraft. We think it is unlikely that the aircraft manufacturers would be willing to disrupt their production process enough to switch producers. Further, given the mission criticality of these products and in some cases the complexity of integrating them within an aircraft design, we don’t think that it is likely that the manufacturers would be willing to take a risk on an unproven supplier.

We believe that Collins also benefits from substantial intangible assets stemming from the know-how required to produce these components and regulatory assets stemming from the certification process, but these distinguish the firm less distinctly from competitors than its switching costs. Several aerospace and defense companies produce highly specialized sensors for various aircraft, and we think the know-how required to replicate these products is substantial but not insurmountable.

Many of Collins' products operate in a razor-and-blade business model. The majority of Collins' commercial revenue (not government- or defense-related) comes from aftermarket parts and services, accounting for as much as 40% of the segment's overall revenue. This dynamic with a large installed product base confers enormous benefits on incumbents in the form of recurring and predictable revenue streams, often at very high contribution margins, and presents a meaningful barrier for entrants, who would need to take on likely unmaintainable losses to develop and market a product without any service revenue in the same category to maintain it.

We assign Pratt & Whitney a wide moat. It develops, manufactures, and services jet engines and power turbines for civil and military aircraft, and clearly displays the dynamic of high development costs yielding a high net present value business. While the company has substantial and sticky military exposure as the sole engine producer for the F-35 fighter jet (the largest military program in history), the main driver for this segment remains jet engines for civil aircraft, specifically the GTF engine used on the popular Airbus A320 and A220 models. The simplest explanation of this segment’s business model is that it operates as an industrial-scale version of the razor-and-blade business: jet engines are sold along with long-term contracts that include incentives and discounts for airlines to commit to use the manufacturer's parts and service capacity. Several times in the two decades of a typical jet engine's service life, it will spend several weeks up to a few months in the engine shop to be overhauled (while a spare engine keeps the airline's prized jet flying passengers). The revenue associated with such an overhaul can approach or exceed the net purchase price of a new engine. Thus in terms of the moat, we see the original manufacturing aspect benefiting most from the intangible asset of the upfront cost and learning curve of developing the engine, and the aftermarket aspect benefiting from intense customer switching costs (often contractual and reinforced by flight regulations).

Jet engine production for narrow- and wide-bodied aircraft is an oligopoly, with four companies taking virtually all the market. We generally attribute market structure to intangible assets in the form of engineering know-how and some switching costs in the form of a conservative client base, ensuring adoption of the product. The difficulty of replicating technology can be seen in the time required to develop an engine, as it took about 20 years for Pratt & Whitney to develop the GTF. The most direct competitor, the Leap engine made by a GE Aerospace-Safran joint venture, CFM International, took around half the time to develop but was more based on existing architecture than the GTF. Legacy United Technologies spent roughly 4% of consolidated sales on research and development, and we estimate that much of this went to support the large capital requirements of engine development, as a more pure-play engine manufacturer, Safran, spent just under 6% of sales (amounting to around EUR 2 billion) on research and development in 2018. While spending on research and development does not inherently generate a moat, we use this to show that the process of developing the engineering know-how required is not easy to replicate. Incumbents have evidence of their product operating as intended for decades and are a trusted partner of manufacturers and airlines. With potentially lethal ramifications of an engine malfunction, we think that customers are unlikely to switch to an untrusted producer. We also view the fact that the four-company oligopoly has remained over several decades as indicative of the difficulty of entering this market.

Pratt & Whitney competes in a duopoly with CFM to power the large and growing narrow-body jet market. The GTF has about a 42% share of current orders for Airbus’ A320neo aircraft and a 100% share of the A220 regional jet, but is not sourced on Boeing’s 737 MAX aircraft. Given that Pratt & Whitney has a minority share of the aircraft program with the largest backlog and no share of the second-largest program, it will not see quite the same volume as CFM in the narrow-body market, but we think the tailwinds behind this market are strong enough to propel both players to economic profits for decades to come. We’re secularly bullish on narrow-bodies because of the global growth of the middle class, who demand air travel as their economies grow, as well as demand in developed markets to replace older planes and their less-efficient engines.

We estimate the GTF fleet could exceed 7,000 engines by 2026, with the recurring, profitable revenue stream from aftermarket parts and service spanning decades and likely exceeding $10 billion annually in its maturity. Further reinforcing the switching costs in the aftermarket for jet engines is the fact that flight regulators certify the airworthiness of an airframe with a given engine model, and the manufacturer determines the required maintenance schedule and parts manual.

We assign the Raytheon segment a wide moat based on intangible assets, stemming from product complexity and a contract structure that largely grants monopolies (at the program level) to government suppliers, and switching costs, largely due to the mission criticality of the product, long product cycles, and a lack of viable alternative suppliers once a program is in production. This segment is largely focused on producing missiles, such as the standard missile family, which is the Navy’s primary shipborne surface-to-air missile, and missile defense systems, such as the Patriot, which is an integral part of the United States’ and allied nations’ missile defense systems. We believe the moatiness of the defense prime contractor industry is evident through the stability of the industry structure over the last 15 years: the top seven arms producers globally have remained Lockheed Martin, Boeing's defense unit, Northrop Grumman, RTX, General Dynamics, BAE Systems, and Airbus. Further, we observe durable profit margins that do not swing in time with the general economic cycle, which further supports RTX's wide moat. Geopolitical tensions and outright warfare have reversed a longer trend toward shrinking military budgets, with NATO-aligned countries having pledged to increase their spending to 3.5% of GDP on defense versus prior targets of 2%.

Missile defense programs are a decidedly complex and long-cycle product, as these require shooting a high-velocity projectile with another projectile midair. The two leaders in short-range missile defense are the Patriot missile defense system to defend against missiles on land and Lockheed’s Aegis missile defense system, which enables warships to shoot down ballistic missiles. We expect continued investment in missile defense, as adversary states are actively developing hypersonic missiles that would penetrate current systems. Raytheon’s Patriot system is the primary land-based missile defense system, and it requires highly integrated radar, secure communications, and interceptors to prevent the adversary's missile from reaching its target.

We also think the missiles subsegment of this business has a wide moat. The product complexity for missiles is quite high. Modern missiles require unique technology for high-speed propulsion over many miles and a variety of guidance technologies for targeting. Finally, the customer tends to order these products in larger blocks, so the contractor must have substantial scale to satisfy customer needs. We believe the substantial technical know-how required to build missiles and integrate missiles within various military aircraft provides a steep barrier to entry, and that nondefense contractors would be unwilling to make the substantial fixed cost investment required to enter this market. On switching costs, while these products themselves are short cycle, as they must be purchased relatively frequently to replenish detonated munitions, we see durable switching costs in the integration of these missiles as part of longer cycle platforms such as ships and aircraft, and the mission criticality of the missile operating as intended. Modern missiles are integrated with advanced targeting technology, and an improperly functioning missile could cause civilian or allied soldier casualties. Raytheon’s Standard missile family has been one of the backbones of the US’ shipborne missile systems since the 1960s, and we expect that Raytheon’s expertise in the field will allow it to continue winning contracts for the foreseeable future.

We also see Raytheon's sensors and secure communications business as having a wide moat. Within the sensors business, we see intangible assets stemming from the deep know-how required to create these high-end sensors and switching costs resulting from mission criticality and being deeply integrated within longer-cycle products. The ability for soldiers to understand the movements of adversaries and to jam their communications is a force multiplier for the military. Since adversaries actively work to disrupt the ability of sensors to function as intended, we expect that the customer is highly sensitive to changes in the quality of the sensor or jammer. Many of the sensors are deeply integrated into military aircraft and ships, which have product cycles lasting decades. Assuming the product continues to work as intended, we think that the difficulty of redesigning the aircraft or ship makes it such that the customer would be much more willing to upgrade the sensor than to switch to a different provider.

Pratt & Whitney’s placement on the A320 family and A220 aircraft should substantially increase the company’s installed base of engines in coming years, unlocking decades of high-margin servicing revenue.

The missile and missile defense segment makes products that are prioritized by the National Defense Strategy, which should lead to robust growth in the near term, at least.

RTX is well balanced between commercial aerospace and defense, which would partially insulate the firm from a downturn in either segment.

One of the driving factors behind the breakup of United Technologies was to create more-focused businesses. While the combined RTX is concentrated on aerospace and defense, it is still large and complex.

Boeing and Airbus have a vested interest in compressing the margins of their component suppliers, such as Collins.

Repairing manufacturing defects in some Pratt & Whitney engines has cost the company billions in compensation to customers and may reduce airlines' appetite for the products.