Shares in aerospace and defense giant Raytheon Technologies (RTX +0.55%) are up 10% over the last year, and if the company can at least meet its medium-term targets, the stock has even more upside potential. Let's take a look at what management has laid out for 2025 and why the company has the potential to deliver results ahead of its targets.
What's planned for 2025
In the company's investor day presentation in May 2021, management laid out the following targets for 2025:
- Sales growth at a compound annual growth rate (CAGR) of 6% to 7% from 2020 to 2025, with adjusted pro forma 2020 revenue at $64.6 billion
- Segment margin expansion of 550 basis points to 650 basis points (100 basis points equal 1%) from 2020 to 2025, with adjusted pro forma 2020 segment margin of 7.9%
- Free cash flow (FCF) of $10 billion in 2025, with pro forma 2020 FCF of $2.3 billion
If you are wondering, the 2020 figures are "pro forma" because they were the results before the merger of Raytheon and United Technologies was complete.
NYSE: RTX
Key Data Points
How Raytheon is tracking these targets
The sales growth target implies sales of $86.4 billion to $90 billion by 2025. While that's possible, Raytheon will need to improve its growth rate annually. For example, Wall Street analysts have sales improving by 8% to $72.5 billion in 2023, then 8.3% to $78.6 billion in 2024. If Wall Street's projections are correct, then the company would need to post revenue growth of 10% to 14.5% in 2025 to achieve management's target.
While the 2025 range looks like a stretch, there are reasons to believe that the company can hit the target. The margin expansion plans point to a segment margin of 13.4% to 14.4%. By my calculations, Raytheon's trailing-12-month segment profit margin is 9.6%. Raytheon has made progress since 2020, but it has work to do.
Lastly, management had projected $6 billion in FCF for 2022, only to reduce it to $4 billion due to the impact of legislation requiring capitalization of research expenses -- it simply means Raytheon will have to make an upfront cash payment of $2 billion in 2022.
One red flag
Raytheon and other aerospace and defense heavyweights suffered ongoing supply chain and labor issues in 2022. Unfortunately, they turned out to be worse than expected and will extend into 2023. Raytheon and Boeing's management have been vocal about the difficulty of acquiring skilled workers. Earlier in the year, Raytheon CEO Greg Hayes outlined that, despite making 23,000 hires in 2022, it still had 13,000 job openings.
In addition, supply chain constraints -- such as replacing titanium castings previously sourced from Russia -- have held back production. Due to these issues, Raytheon lowered its earnings guidance for its defense-focused businesses in 2022. Stronger-than-expected commercial aerospace growth means Raytheon has slightly nudged up its full-year earnings guidance to between $4.70 and $4.80 from a previous range of $4.60 to $4.80 at the start of the year.
Three green flags
That said, there are three reasons why Raytheon can outperform its expectations laid out in 2021.
First, on the investor day presentation, the two defense-focused businesses (Raytheon Intelligence & Space and Raytheon Missiles & Defense) were forecast to grow at a CAGR of 4% to 5% and 3% to 4%, respectively, from 2020 to 2025. However, at an investment conference in September, CFO Neil Mitchill said he expected the defense businesses to grow at a mid- to high-single-digit rate until 2025 -- driven by increased interest in its defense systems due to the conflict in Ukraine.
Second, at the time of the company's creation in 2020, management expected $1 billion in run rate synergies from the merger. The figure was upgraded to $1.3 billion on investor day in 2021, but now management is aiming for $1.5 billion, with $1.3 billion of it coming by the end of 2022.
Third, as noted earlier, the strength of the recovery in commercial flight departures means Raytheon is outperforming its expectations in commercial aerospace at present. While that speaks to ongoing strength in the aftermarket, its original equipment (OE) sales will get a boost as airplane production ramps up at Boeing and Airbus.
At the Morgan Stanley Laguna conference in September, Hayes said that based on assumptions for Boeing 737 production at a rate of 42 to 48 a month in 2025 and Airbus A320 at a rate of 65 a month in 2025, "you would see over a 50% increase in OE revenue between Pratt and Collins between now and 2025."
However, Airbus continues to expect to hit 75 a month in 2025 and at Boeing's recent investor conference management called for 50 a month in 2025. As such, Raytheon's growth might be more than currently expected.
All told, Raytheon has plenty of potential to hit its 2025 targets and even exceed them as its defense business outlook strengthens and the recovery in commercial aerospace continues to exceed expectations.
