Is Raytheon Company a Buy?

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Raytheon (NYSE:RTN), with its focus on missiles, radars, sensors, and missile defense, has been one of the big winners from recent hikes in defense spending, its stock up more than 80% over the last three years. That gain has come without much help in 2018. Shares of the company are actually down 4.5% year to date after first-quarter results raised concerns that shares had gotten ahead of themselves.

The company’s second quarter, which included a beat on both earnings and revenue and raised full-year guidance but also cash flow disappointment, was met with a tepid reaction on Wall Street.

Patriot missile system firing

A Raytheon-made Patriot missile battery. Image source: Raytheon.

Here’s a look at Raytheon’s recent results and outlook for the future to try to determine whether the company is currently a buy.

A beat and a raise

Raytheon reported second-quarter earnings per share of $2.45, excluding $0.33 pension gain, beating estimates by $0.10 per share, on revenue of $6.63 billion. Sales were up more than 5% year over year and came in $120 million above consensus.

The company credited the increase to wins in its intelligence segment, where operating income grew 11% from last year to $128 million and revenue was up 8%. Raytheon’s backlog at the end of the quarter stood at $39.88 billion, up from $36.17 billion last year.

Not all the numbers were to Wall Street’s liking, though. Raytheon cut its full-year operating cash flow guidance to $2.6 billion to $3 billion, down from $3.6 billion to $4 billion, after making a $1.25 billion pension contribution. Raytheon said the move would help reduce its overall tax obligation, bringing its effective tax-rate guidance for the year to 10.5% from 18%, but the cash hit was blamed for company shares falling more than 3% after the July 26 announcement.

Raytheon is also taking a non-cash pension settlement charge of $288 million in the current third quarter that will result in a one-time $0.79 earnings-per-share reduction.

The overall outlook for the year remains strong. Raytheon said it expects full-year earnings of between $9.77 and $9.97 per share, up from previous guidance of $9.70 to $9.90 per share. Full-year sales guidance was also upped by about $200 million, to a range of $26.7 billion to $27.2 billion.

Missile master

While it was classified work that led to the beat this quarter, Raytheon’s rosy outlook is based in large part on growing worldwide demand for its missile and antimissile systems. At home, the Pentagon has made munition replenishment a top priority, which should lead to elevated orders and production well into the next decade.

Congress authorized the purchase of more than 48,000 bombs and missiles in fiscal 2019, a 20% increase over 2018, while increasing missile defense spending by nearly 25% to $9.9 billion. Over the next five years, the Pentagon expects to invest about $47 billion in missile defense, about $14 billion above the last five-year plan estimate.

The big winners from this trend include Raytheon, Boeing, and Lockheed Martin, with Raytheon both a maker of munitions such as laser-guided bombs, Tomahawk missiles, and interceptors and of the radar and electronics on antimissile systems made by Lockheed and other vendors.

Raytheon should also benefit from increased demand overseas. The company is the most diverse U.S. prime contractor in terms of international sales, with foreign customers accounting for about one-third of total revenue and more than 40% of its backlog. Raytheon’s Patriot missile systems are deployed across the Middle East and in a growing number of European countries.

Is Raytheon a buy?

Coming out of earnings season, Raytheon is my second-favorite stock among defense primes. There is greater potential for upside at General Dynamics due to optimism over a recovery at its commercial unit, but Raytheon seems well set up to follow this quarter’s beat and raise with similarly strong results in the quarters to come.

The company’s book-to-bill ratio for the quarter, at 1.31, is as good as any I’ve seen in the sector this quarter, and with the Pentagon earlier in the year saying that it expects to increase the pace of new awards in the second half of the year, new missile and classified awards should continue to roll in.

RTN PE Ratio (TTM) Chart

Defense PE and PS Ratios (TTM) data by YCharts.

Raytheon isn’t cheap, trailing only Lockheed Martin among defense majors in terms of price to earnings and the most expensive of the group in terms of price to sales, but the outlook for increased business makes me increasingly confident that Raytheon can, if nothing else, grow into the lofty valuation that followed its strong three-year stock surge, if not improve on it over time.

It’s hard to imagine Raytheon shares climbing another 80% over the next three years, but it can be an outperformer among industrial companies. For investors seeking stability with the potential for some upside, Raytheon is a solid buy.

Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.