Raytheon Technologies Corporation (RTX) Presents at Barclays Industrial Select Conference (Transcript)

Raytheon Technologies Corporation (NYSE:RTX) Barclays Industrial Select Conference Call February 22, 2023 9:10 AM ET

Company Participants

Neil Mitchill - CFO

Greg Hayes - Chairman and CEO

Conference Call Participants

David Strauss - Barclays

David Strauss

I keep reiterating, he’s been a strong support of this conference, seems to make it every year. So thank you for that. And Neil Mitchill, Chief Financial Officer of Raytheon Technology.

So with that, hand it over to Greg for some opening comments and necessary disclaimers and disclosures.

Greg Hayes

Thanks, David. And as long as you keep having the conference in Miami, I suspect we will continue to attend religiously. So just before we get started, a reminder, this is being webcast and we will have some forward-looking statements that are subject to risks and uncertainties. All of that, I would recommend you look at our most recent Form 10-K, which lays those risks and challenges out in detail.

With that, let me just spend just a second on ‘22 because I think it really sets the stage for where we see the company going for the next several years. And so last year, we had solid organic growth, about 6%, solid bottom line growth, EPS about 12%. And that was despite $2 billion of inflation, which is about twice what we had planned going into the year.

And not surprisingly, we saw that inflation across supply chain. We saw that across employment costs. But for the most part, we were able to overcome it, and we were actually able to hit the guidance that we had laid out back in January of ‘22. Cash flow, again, pretty strong, a little stronger even than what we expected. That was despite about a $1.6 billion cash tax payment to the government because of the R&D amortization. So good news there.

I think the best news about ‘22, not that we just survived it, but our backlog exiting ‘22 was $175 billion, nearly $70 billion of that on the defense side. That really does set us up as we think about ‘23 and beyond for very solid top line and bottom line growth as we go -- look to the next 3 years.

On the commercial area, as we entered this year, roughly 75% of the way back to 2019 prepandemic levels of air traffic. We expect by the time we exit this year, we should be almost back to full 2019 levels. Probably stronger on the domestic single-aisle side, a little bit weaker on wide-body, but pretty close to 2019. So to say the pandemic is over may be a bit of a misnomer, but we clearly see the recovery taking hold as we go throughout the rest of this year. And you can see it especially in China, which is about 14% of the world’s RPMs, revenue passenger miles. Again, very strong rebound as they’ve opened up the country there.

On the defense side, again, I go to the backlog. We see what’s happening every day in Ukraine. We see the challenges in the Indo-Pacific region. All of those threats and the threat environment being as elevated as it is bodes well for the technologies that we can bring to bear. And I think, again, we see very solid growth this year in defense, but not just this year. It really will be a multiyear recovery in defense spending and the good thing, that sets us up very well.

I’ll turn it to Neil. He can take us through the actual ‘23 guidance that we gave in January just to reiterate it. And we’ll come back and take the questions.

Neil Mitchill

Great. Thanks, Greg, and it’s great to be here. No change to our RTX level guidance today. So we see about 7% to 9% organic sales growth. That’s between $72 billion and $73 billion. Earnings per share of $4.90 to $5.05. Obviously, we have some pension headwind in there and some tax headwind, but very good operating segment growth. We’ll see operating segment profit growth at all 4 of the businesses this year, based on all the backdrop that Greg just talked about in terms of the growing backlog, the commercial aero recovery in particular.

And then on the free cash flow side, $4.8 billion or so is our outlook as of today. Again, we’ve got about $0.5 billion pension headwind. We’ve got some higher capital of a couple of hundred million dollars and higher interest in some corporate-related restructuring that we anticipate this year. All of that gets us to about $4.8 billion as we look at the rest of this year.

Question-and-Answer Session

Q - David Strauss

Great. Thanks for those comments. So first thing I want to touch on, one of the big things on the Q4 call was the announcement that you’re going to be streamlining to 3 segments, taking the 2 former Raytheon segments into one. I guess what drove this? How does this fit in terms of your overall priority executing on this, how does that fit into your overall priorities for this year? And how does that all flow through to how you’re thinking about the trajectory of ‘25?

Greg Hayes

Dave, it’s something that we gave a lot of thought to. In fact, this was probably over a year in the making in terms of how are we going to set the company up to recognize and to realize the benefits of the merger. And we’ve been talking for the last 3 years, it’s been almost 3 years since we came together as Raytheon Technology is about how do we take technology from the defense side and the commercial side, put them together in packages that can solve some of our customers’ most difficult problems.

And what we found -- again, we have great technology spread across all the businesses. But because they were individual businesses with individual P&Ls and their own priorities. What we saw is that we were missing opportunities. Missing opportunities to work across the enterprise. And I’ll give you 2 examples that were most compelling to us.

One was on JADC2. JADC2 is joint demand command and control. This is the military’s jargon for how do you make sure that you can communicate across all of the spectrum from space, to air, to sea, to land, to ocean and underwater in a contested battle space. It’s a really difficult problem. And we have folks within our RIS segment that we’re working at. We had folks within Collins and even a few within RMD, and we never really could come together as a single company in terms of our approach to solving this problem.

The other one I would tell you is on the FAA side to -- so again, we do all the radars for the FAA. We do avionics. We do all of this other work for FAA spread across the business units. And we really saw that we were sub-optimizing in terms of our ability to solve these technical customer problems.

And so as we thought through this, how best to organize, we saw the ability to move pieces of RIS from its current home into Collins. Some pieces of it will go into RMD. Pratt pretty much stays alone. But at the end of the day, we thought we would have 3 big business units, Pratt & Whitney, Collins, and Raytheon as we’re going to call this new segment, all with roughly $25 billion to $27 billion of revenue next year, but all also laser-focused on specific customer needs.

So missiles, defense and space will be in the Raytheon segment. The comms, JADC2, FAA, will most likely be within the Collins segment. Pratt pretty much stays as it is. But again, the whole idea here was how do you unlock the revenue synergies. And we think we’ve identified roughly $12 billion of revenue synergy opportunities that we can realize through this realignment. Today, we’ve only realized about $1 billion of that $12 billion. So there’s a big opportunity to spur growth through this realignment.

David Strauss

Yes. Update on supply chain, I think probably your favorite topic. Where are things getting better? Not getting better? Maybe by business. And then you touched on the inflation headwind you took last year, the inflation headwind you expect. Are you seeing any sort of easing on the inflation front?

Greg Hayes

Yes. Look, so I’ve been in the aerospace business now going on, I have to say, 34 years, and I’ve been worried about supply chain for about 33.5 years. First half-year, I didn’t know what the hell I was doing, so I didn’t really understand it. The fact is, supply chain is getting better, incrementally.

We still have problem suppliers out there. We’ve talked all about these over the last year. But I would tell you, on the whole supply chain is getting better chips specifically. We saw this as a huge problem a year ago. We were able to work deals with many of the distributors and many of the manufacturers. I would now say that chips for the most part are no longer an issue.

We had some casting issues at Pratt & Whitney that was holding up delivery of engines to Airbus and other customers. That issue is still out there, although yields are getting better, processes are improving. Getting better probably won’t be completely solved back on contract until the end of the year. Rocket motors, a bane of my existence, continued to be a problem. And as -- that goes to yields and just the on-time delivery. That particular problem we don’t think it’s solved until probably the middle of ‘24.

So -- as I take a look, I mean, there are literally hundreds of hundreds of issues at suppliers. You always have a problem. We had one of our suppliers recently had a fire in one of their factories and that will shut down a couple of production lines for a month or so. But these are just things we work through. And when you have somewhere around 13,000 -- almost 14,000 suppliers, there’s always going to be a few that are problematic. But the big challenges that we saw last year with COVID, chips, I would say that is, for the most part, behind us. And we would expect better performance even as we go through ‘23 here.

David Strauss

And inflation and your ability to offset it with price?

Greg Hayes

So we -- again, if you think about last year, $2 billion of inflation, we were forecasting another $2 billion of inflation this year. And of that $2 billion, about $800 million of it comes from increased employee costs. So think about -- across RTX, we’ve got about $20 billion in compensation costs, 4% raises this year, $800 million. Big number. Supply chain is about another $1.2 billion.

So -- that is the challenge is how do you overcome roughly $2 billion. Pricing will cover about 60% of it or so. And the rest is going to come through productivity and cost reduction. One of the things is -- that we have been able to do with many of our suppliers because suppliers have been late, they have been coming back and saying, "Hey, by the way, we need price increases." And we said, there’s no price increase even contemplated until you’re 100% on time with 100% perfect quality.

And so we have been able to push back a little bit on the supply chain. But inflation is still real, although, again, as we look forward, it seems like the employment costs, which were going through the roof last year, starting to slow down a little bit. We see raw material costs, oil, gas, all of that, starting to moderate again. So I think the big pressure on inflation, including all the excess government spending that we had back in ‘21 and ‘22, is actually abating. So I would expect inflation will start to moderate here in the back half of the year.

David Strauss

Moving over to commercial aero. So first on the aftermarket. So last year, I think you, between Pratt and Collins, you put up about 25% aftermarket growth. I think this year, forecasting differs a little bit by business, but mid-teens range. Can you walk through the drivers of that GTF, V2500, legacy engines, top business provision -- all the -- everything that goes into the aftermarket forecast.

Neil Mitchill

Yes, I’ll take that one, and then we can get Greg to pile on. So yes, Collins, we’re going to see low double-digit to low teens aftermarket growth. Remember, we’ve seen really substantial growth there over the last year. I think you’ll see higher growth levels in the beginning of the year that kind of tail down as the compares get more difficult.

The key driver on the Collins side is really the reopening of China and the expansion of the wide-body traffic routes. So those are the 2 things that we’re really keeping an eye on, particularly in the Asia region of the world. And fortunately, we’ve seen a pretty strong recovery there. If that remains in China, then I expect that Collins will enjoy that aftermarket demand, and that will continue. So that’s the key driver there.

On the Pratt side, we expect to see 20% to 25% aftermarket growth. I talked a little bit at the earnings call about we see the V shop visits going up, call it, from around 700 to the mid-800. So a lot of tailwind there. We’re happy to see that the GTF aftermarket is contributing positively to margins. So that will help in some way growing. We turned positive in 2022, and that will continue to grow back towards V2500-like margins over the next several years. So that’s going to be a key driver there.

And also, you’ve got the Pratt Canada business, the small engine business, continue to see really strong demand for business jets. We will see the regional turboprop market pick up this year as well. All of that will continue to drive aftermarket demand in that business in particular.

We also have the military businesses within both Collins and Pratt, for example. And on the F135 side, we’ll see the aftermarket overtake -- not overtake but offset a little bit softer OE. We’ll see military sales about flattish at Pratt, but you’re seeing that shift from OE to aftermarket. So that’s good.

Greg Hayes

Yes. I would just add a couple of color commentary points here. One, on the V, 3 years ago, we thought the V was kind of going to be petering out. Retirements have been almost non-existent in that fleet. There’s still about 6,000 engines out there, which is double the number of GTF engines in service today. And that aftermarket continues to be very strong. Average time on wing for a V is around 20,000 hours. So you’re getting good reliability, and we’re seeing the shop visits come through. And the shop visits are, as you would expect, with a fleet as old as that, relatively profitable.

The Pratt Canada piece, again, we don’t talk a lot about Pratt Canada. It is kind of the hidden jewel within the Pratt portfolio. But to Neil’s point, there are 60,000 small engines out there that we have, for the most part, all on maintenance service agreements where they are getting cash every hour that the airplanes are flying. And general aviation has been very, very strong.

The other piece of this on the Pratt Canada side is PT6. Now the PT6 has been out there almost 60 years. Later this summer, we will have over 1 billion flight hours on the PT6 engines. That’s an incredible legacy of durability, reliability and customer acceptance of an engine. And I can tell you this, for any of you that have flown any turbo prop out there, it’s probably a PT6 powered engine, and that continues to drive significant aftermarket -- profitable aftermarket growth at Pratt Canada.

David Strauss

You touched on the GTF and I’ll let you take it wherever you want to take it, but negative engine margin, what you’re doing on the GTF advantage and I guess, the on-wing stuff that’s out there?

Greg Hayes

What’s nice is this is like the fourth question and we’re finally getting to GTF. For the last 5 years, it’s always been the first question. So GTF, as I said, so we’ve got about 3,000 engines out there in service, primarily A320 family, A220, but also the Embraer E2 series aircraft. And even on the business jets on the global -- on the Gulfstream 600. So it’s been great, but it has not been as reliable as we would like it to have been. It’s not been as durable.

And I would tell you today, with the recent upgrades and modifications we’ve been working on, and we’re on what I call the deconfiguration, right, so fourth generation of the GTF. We’re getting somewhere around 10,000 hours of time on-wing between overhauls, about half of the V. The challenge over the next 5 years is to get the reliability from where it is today to V2500-like reliability.

And again, we have put in place a number of fixes to the combustor, to the #3 turbine blade, to other parts of the engine where we’ve seen reliability issues. We’re still not where we need to be. And as a result of that, our customers are not particularly happy with the fact that we can’t get engines to them in time. because of the large numbers that are coming in for all of these retrofits. So that will be a challenge for us all year long.

I think it is -- again, V2500 shop visits are great. GTF shop visits are also increasing this year, and that’s going to be a challenge to make sure that we can keep the airplanes in the air with the engines going through the shop as often as they have been. So it remains a challenge.

The good news is last year, we finally crossed the breakeven threshold on GTF aftermarket profitability. We’re still losing a little over $1 million in engine -- in negative engine margin. Again, we’ve come down a learning curve over the last, I guess it’s been 8 years now, roughly an 87% learning curve. But with pandemic, I think we took a step back up. We’re still trying to enter our way back down, but negative engine margin will continue to be an issue at Pratt for a number of years.

David Strauss

And on the new equipment side on commercial aero, you forecasted low to mid-teens growth. How do you frame that in the context of what you’re getting out of the manufacturers in terms of build rates? I mean, we’ve had -- since you reported, we’ve had -- a number of other companies reported, it seems like expectations are still kind of all over the place in terms of manufacturer build rates.

Greg Hayes

Yes, look, I think right now, I would tell you the numbers that Neil just laid out are pretty much in line with what Boeing and Airbus have told us in terms of what the build rates are going to be. There is still a bit of a wait and see here. I know Boeing has come out there with about 31 of the 737 today. There’s an aspiration to get to 38 by the end of the year. We can certainly support that. On the Airbus side, I think last year, they were at 45 of the A320 family a month. Next year, they say they’re going to 65. They didn’t give a specific number for ‘23. But somewhere in that 50, mid-50 range, we’ll be able to support that.

Again, the challenges that we see on the supply chain, I would tell you, all the airline -- aircraft manufacturers see it in spades, right? I mean it is everywhere. So there are still challenges out there in supply chain that I think Boeing and Airbus are working through. I would tell you the forecast that we have put forth for the year in terms of growth support kind of a mid -- a middle of the range in terms of what the aircraft OEMs are forecasting.

David Strauss

That’s fair. So over to the defense side. You touched on at the beginning, the big backlog you had, over 1x book-to-bill in defense last year. I guess question is, when do we see it come through? When does it translate to the kind of growth we’re all anticipating?

Greg Hayes

Well, look, I think -- so book-to-bill, RMD last year was like 1.37, right, really strong. And that was across the board from AMRAAMs to Patriots to NASAMS, everything. As you would expect though, if you order a Patriot air defense system today, you’ll see it probably 2, 2.5 years from now.

NASAMS, again, while it’s in current production, you probably -- and I think we’ve got 6 of those on order for Ukraine. They won’t see those until starting this summer, probably through next year. So this backlog is going to play out over the next 2 or 3 years. The fact is there’s still a lot more to come. With all of the money that’s been allocated to the defense of Ukraine, which is roughly $45 billion, we’ve only seen a little less than $2 billion of actual contracts at Raytheon.

I think if you go across the whole defense industrial base, that number is about $7.5 billion. So there is still a significant amount of demand that has to be contracted to fill in for all of the commitments that we have made to Ukraine. And again, Patriots are a part of that. NASAMS are a part of that. Javelin, Stingers, Excalibur, guided munitions, those are all still on the comm in terms of replacing what has been consumed or been pledged to Ukraine. So I would think this is going to play out over the next 2, 3, 4 years.

And that doesn’t even count what we’re seeing in terms of growth in the INDOPACOM theater where we know there is huge demand for SM-6 missiles, anti-ship missiles. This is kind of the standard load for any one of the destroyers that are out there. And we know that you’ve probably seen all the reporting, we’ve probably got about 7 days’ worth of munitions currently in the fleet, which doesn’t bode well for a long war in the INDOPACOM theater. So there is still demand that’s going to be coming as it relates to many of those things, SM-6 probably being the biggest opportunity for us.

David Strauss

Defense margins, can you talk about what’s been challenging there? How much of it has just been supply chain, inflation, not the ability to price through? How much of it is mix? And how things get better from here?

Neil Mitchill

Yes. Let me start there. When we look at last year, the biggest issue we had was supply chain that really hurt our ability to drive productivity. So the 2 things were related. It’s a little bit of a different story between each of our 2 defense businesses.

On the RIS side, we definitely had some supply chain constraints. We also had a handful of programs that we’ve been working through, development programs, fixed price. Many of them date back to 2015 kind of time frame. And that exacerbated, I would say, the absence of productivity. We’ve taken some charges throughout the year pretty much in each quarter. We still have a little bit of ways to go there, probably another year to 18 months to get through those contracts, but that was certainly a drag.

At RMD, it really was the supply chain. We talked about middle of the year the kit fill rates being at really low levels. That caused a lot of inefficiencies and disruption in the factories. Typically, we would see a couple of hundred million dollars of productivity a year between these 2 businesses. Last year, we saw about $90 million of negative productivity. So year-over-year, about a $288 million headwind.

As we look to ‘23, we think we will see additional productivity. I will tell you that I expect that productivity to be more back end loaded. We could see a bit more of a headwind here in the first quarter in RIS in particular. But I think as the material flows, and getting back to one of your earlier questions, what we talked earlier about an 8% material year-over-year increase in RMD. Here in the first quarter, we’re probably going to see about half that rate of year-over-year growth, which was planned. So far seen that level of activity. So again, that will kind of improve over the course of the year as the supply chain recovers.

So as I sit here today, it really is about regaining flow of materials through the factories and making sure that we’re able to generate the productivity that we’re used to, which comes in the form of higher volume production activity as opposed to a lot of development activity that we’ve been doing, getting to your mix question, which has also been a factor.

In RMD, in particular, we’ve been upgrading a lot of legacy equipment. So while it still has names that go back sometimes 30 years, a lot of that equipment got new upgrades over the last year. That had the added effect of putting some pressure into the supply chain as the designs have changed and lead times expanded on us at the same time. So I am confident in what we have in the forecast for this year. We still have a ways to go, but we are starting to see that slowly improve as the year unfolds so far.

Greg Hayes

Dave, the only thing I would add to that is we blame everything on supply chain because it’s easy. The fact is, I’d say, we missed some of the big changes that were happening in the marketplace around lead times and around raw material availability, and we were late to recognize some of those expanded lead times. We didn’t get things on PO as quickly as we can. We had designs that were not completely mature that we were releasing into the supply chain that had to have parts reworked.

There was a -- host of, I would say, internal issues on top of just the supply chain performance. I would say Chris Calio and Wes Kremer have made some changes operationally and improved some of the personnel in that organization because we really need to get on top of this.

I would tell you, Collins did a great job with supply chain last year. They had the same challenges. They got on top of it a little bit more quickly. RMD, we did not make the same progress. We weren’t as proactive. So again, I think those issues, which caused some of this drama last year, will be behind us just because I think we’ve got the right people now in place to execute on this.

David Strauss

Capital deployment. Did $6 billion last year. Guide to that level again this year. You have the $20 billion target, which seems like you’ll easily achieve, but you also have this R&D drag, amortization drag, that you weren’t expecting. So you have to potentially finance some of this. So how are you thinking about that? And then just to layer on here. M&A, you talked about potential for further portfolio shaping in the past -- leave it at that.

Greg Hayes

All right. Let’s talk about capital allocation there’s a thousand things to say there. Let’s just start with the dividend, right? So dividend is about a $3.2 billion call on cash. Dividend is sacrosanct in my mind, and we will continue to raise the dividend in line with earnings over the next several years. Share buyback is kind of the fill in, but we see about $3 billion this year, $2.8 billion last year. Since the merger, by the end of the year we’ll be just under $19.5 billion returned to shareholders. So pretty close.

And with dividend payments in the first quarter, we will more than exceed the $20 billion target that we had laid out. But we’re not done. I would tell you, as we think about cash over the next several years, growing from just under $5 billion this year to around $9 billion by 2025, we’ll have opportunities to continue to increase the dividend and increase share buyback.

I don’t think there is much in the way of M&A out there today. There may be -- and again, we’ve done some small bolt-ons like SEAKR and Blue Canyon Technologies, but for the most part, given the regulatory environment of Washington, I think, any type of deal is difficult to do. Having said that, there are probably some pieces of the portfolio within the 4 walls of RTX that we feel are not optimal in terms of long-term growth. So we’ll be doing some of those potential divestitures over the course of this year and next.

Again, we’ve been talking about it for 3 years, and we haven’t done anything, quite frankly, because the market has been so bad. But with the recovery in commercial aerospace, I think there’s a better opportunity today to monetize some of these assets and find a better home for a couple of the businesses. And again, you’ll see us talking about that here probably at the end of the first quarter into the second quarter. And hopefully, by the time you get to June, we’ll do an Investor Day at the Paris Air Show. We’ll be able to shed some more light on that.

David Strauss

So you mentioned the cash flow improvement from $5 billion to $9 billion. Can you help us -- I mean it’s a big lift. You’ve got a pension headwind in there. You get some relief on R&D amortization over time. A lot of it is driven by underlying growth in the business. But what does that mean? Is it $5 billion, $7 billion, $9 billion? How do we get comfortable? What does that path look like and how do we get comfortable with it? Save the best for last.

Neil Mitchill

So yes -- sorry, let me start. I’ll give you the walk. So let’s talk about $5 billion-ish of free cash flow in 2022. We’ll have $5 billion of after-tax profit growth between ‘22 and ‘25. And $1 billion, unfortunately, of pension headwind in the form of lower CAS recoveries. We also have about $0.5 billion of increased capital as we continue to invest for the near and the long term. So that’s sort of the big pieces of the walk.

If you look at that $5 billion of after-tax profit growth, 80% of that or so is going to come from Pratt and Collins. Of that piece, up to 75% of that is going to be driven by aftermarket. And so as you think about where are we going to be in 2025 as it relates to a commercial aero recovery, we think we’re fully recovered by then. We probably still have a little bit of recovery left in the wide body. We’ll see it’s a little bit further out there. But the way that it’s going to happen is it’s going to be related to that air traffic getting back to those historic levels and then continuing to grow in the mid-single-digit range that we’re all used to prepandemic.

And I think as you think about how that’s going to happen, I think that’s going to be relatively correlated to this continued recovery and the delivery of new aircraft that we all see in the rates from the OEMs that we’ve been talking a lot about. So those are the things we’re watching over the next months and years as we execute those plans. But I feel confident in that ability, if we get the [RPKs] and we get the OE deliveries out there as anticipated.

David Strauss

Do you need working capital help it to that number?

Neil Mitchill

We’re going to be very strategic with the working capital deployment here. I don’t think we need a lot of working capital help to get to that number. It’s in the hundreds of millions of dollars kind of range.

Greg Hayes

I mean R&D amortization was also beneficial in ‘22. That’s about $1 billion of outflow in 2025 with additional interest and all...

Greg Hayes

Which is $1.6 billion. So you pick up about $600 million just in the amortization.

Neil Mitchill

Yes. That’s right, yes. Exactly.

David Strauss

Okay. All right, the audience participation portion of the program. I know Greg likes it.

Greg Hayes

Great for us.

David Strauss

So -- yes. If you could please participate, we would appreciate it, maybe this year with the keypads right front. So can we start the clock on the first question, please? Next question, please.

Greg Hayes

Very good distribution.

David Strauss

You’re welcome to comment. Next question. Thru cycle UPS growth. Next question, please.

Greg Hayes

I already know the answer to this one. Yes, 3 and 4.

David Strauss

Closer than...

Greg Hayes

Yes, it’s actually closer.

David Strauss

Next question, please. What multiple -- that’s good. Next question, please. Everything. And I think we have a last one on -- the new question for this year. Might be late to the party, but who knows.

Greg Hayes

Pretty even.

David Strauss

All right. Thank you very much. Thanks, Greg.

Greg Hayes

Thank you, David.

David Strauss

Thanks, Neil.

Neil Mitchill

Yes.

Greg Hayes

Yes. You, too.