Tony Marturano/iStock via Getty Images Introduction 2022 was a volatile year for the markets and geopolitics. As the fed raised rates, Russia levied missiles into Ukraine. In times of instability, companies that execute with consistency become just that more important. Data by YCharts Let’s see if Raytheon (RTX) is one of those rare consistent companies. Raytheon, for those that don’t know already, is a leading aerospace and defense contractor specializing in producing advanced technology systems for various government and commercial customers, most notably the USA. They are known for developing radar, electronic warfare, and other sensor systems for military and commercial applications. It is a major producer of missile systems, including the Patriot Missile family of products, which were recently announced to be sent to Ukraine. The company has long-standing relationships with the U.S. Department of Defense and other government agencies, as well as with major commercial customers such as Boeing and Airbus providing stability in the face of global worry. Within this article I’ll discuss: The defense industry and Raytheon Raytheon’s financial and operational performance My price target for Raytheon’s stock We make war that we may live in peace. – Aristotle The Defense Industry and Raytheon Let’s discuss some of the drivers that make the defense industry attractive at a high level as several secular growth stories are providing strong tailwinds for Raytheon. The three largest drivers of growth, as I see them, are the global modernization of militaries worldwide, increased global security concerns, and bloated government spending. Military Modernization Following a period of relative peace many militaries have entered a period of modernization and reinvestment. Germany, for example, shocked the world when it announced an investment of 100B Euros into its military following the invasion of Ukraine marking a sharp reversal in German political strategy. As companies reassess defense needs I believe spending will increase for Raytheon’s products over time. Militaries worldwide must continue to invest in modernizing their equipment and technology to keep up with the changing “cat and mouse” nature of warfare. The increased focus on advanced technology systems, such as stealth technology, hypersonic missiles, and unmanned systems, has led to increased spending on research and development. This has, in turn, driven growth in the defense industry and likely increased orders for advanced weaponry like that of the Patriot missile system produced by Raytheon. Global Security Concerns Global security concerns serve as a recurring reminder for governments to invest in their defense and military systems. Whether it’s the war on terror, the war in Ukraine, or any other number of global conflicts, there seems to be a near-constant threat lurking in the darkness. “Evil never dies. It merely waits. And it grows stronger in the dark.”― Jonathan Maberry The west has been involved in various conflicts in the Middle East, Asia, and Africa, which has led to the development of new weapons systems and the procurement of existing systems. Additionally, the threats of terrorism through cyber-attacks have led to increased demand for advanced technology systems, such as drones, and cyber security systems. For example, the hacking of the colonial pipeline reinforces the need to have protection in both the physical and digital worlds. Bloated Government Spending It should come as no surprise that the US government is the largest customer for the defense industry and that the increased spending on national defense has driven growth in the industry. Global Defense Spending (Stockholm International Peace Research Institute) As you can see in the chart above, the USA spends ~3.7% of its GDP on defense, a number equates to over $750B per annum! This $750B+ includes spending on new weapons systems, research and development, and maintenance and upgrade of existing systems. The US Department of Defense (DOD) budget has been a major contributor to the growth of the defense industry. As the chart indicates, the USA, China, and Russia, all continue to invest more in their militaries, both in terms of dollars and in terms of % of GDP. Raytheon and its peers are direct beneficiaries of this increased spending. Raytheon Financials vs Peers Now unfortunately for Raytheon, this is where the story begins to sour, compared to its peers Raytheon lags in many regards. Revenue Growth Data by YCharts Let’s start with the bright side, over the last couple of years Raytheon has outpaced its peers in revenue growth. This was likely, at least in part, driven by increased sales of its patriot missile system to countries in Europe like the Netherlands. Still, given the global tailwinds, one might expect revenue growth of over 6%. Operating Margin Data by YCharts Alas, compared to its peers, at only 8%, Raytheon’s operating margin leaves investors wanting more. Lockheed’s (LMT) operating margin is 13% and most of the other defense peers are around the 10% range meaning Raytheon is a relative under-performer. Return on Invested Capital Data by YCharts The disappointing trend continues for Raytheon when looking at their returns on invested capital. At only 4.25%, and with a 3-year median of 3.43% Raytheon’s ROIC is just, flat-out, disappointing… With 2-year treasuries yielding more than 4% I’m not especially confident in Raytheon’s ability to deploy capital for shareholders. Conclusion Raytheon is an interesting company. It produces some of the sophisticated weaponry that money can buy, and it is also supported by extremely strong tailwinds. The challenge for Raytheon seems to be on execution as its operating margin and ROIC capital are worst in class among its peers. Data by YCharts Despite the cons, for whatever reason, Raytheon is still one of the most richly valued defense contractors. This, to me, is head-scratching. I want to rate Raytheon a Sell, but given the strong secular tailwinds helping to drive consistent demand, I simply cannot do so. I rate Raytheon a hold. Thank You Thank you for reading! I hope you enjoyed the article. Is there something I am missing about Raytheon that makes it worth the relative premium? Please feel free to let me know in the comments below. All the best! Also, I may consider imitating a long position in Lockheed Martin after discovering their relative strength in both margins, and capital deployment. Still need to do some more research but the financials look promising.
