Final summer time when United Applied sciences agreed to merge its aerospace business with Raytheon, the 2 administration groups talked up the “stability” that may be achieved by combining UTX’s business aerospace-heavy portfolio with Raytheon’s defense-focused enterprise. The purpose, they stated, was to create an organization that might journey out the inevitable down cycles frequent to each the business aerospace and protection companies.

Little did they understand how quickly that thesis can be put to the check. The 2 firms closed their deal on April 3, forming Raytheon Applied sciences (NYSE:RTX) simply because the COVID-19 pandemic was inflicting the business aerospace sector to break down. United Applied sciences shares had misplaced practically half their worth year-to-date previous to the deal closing, and absent the deal, the fall could have been much steeper.

This is a take a look at the challenges that face Raytheon Applied sciences, and what buyers ought to anticipate from the newly fashioned aerospace large within the quarters to return.

COVID-19 will crimp business aerospace revenues

United Applied sciences can hint its historical past again to William Boeing and the early days of aviation, and its portfolio nonetheless consists of among the greatest names in aerospace, comparable to Pratt & Whitney (engines) and Rockwell Collins (avionics and plane interiors). The enterprise serves each the defense and business sectors, however counts on business aerospace for the majority of its income.

The COVID-19 pandemic has brought about air journey demand to break down, and airways that simply months in the past have been trying to broaden are actually in survival mode. That has meant reducing flights, grounding plane, and deferring orders for brand new planes. With air visitors not anticipated to completely recuperate to pre-pandemic ranges for 3 years or extra, demand for brand new planes, engines, and spare components is prone to be low for the foreseeable future.

Two Pratt & Whitney employees work on an aircraft engine.

Picture supply: Raytheon Applied sciences.

Pratt & Whitney and Collins Aerospace are among the many affected. Raytheon on April 14 introduced 10% pay cuts for salaried staff within the company places of work and staff within the commercial-focused companies. The companies are additionally implementing furlough applications for hourly staff, which can proceed as wanted.

Within the memo to workers asserting the cuts, CEO Greg Hayes (previously head of United Applied sciences) stated they’re “non permanent measures that we should take to responsibly handle the corporate by way of the enterprise repercussions of the COVID-19 pandemic.”

Total, the corporate intends to chop about $2 billion in prices and take different actions to preserve about $Four billion in money on the business aerospace facet.

Protection to the rescue

In a tough setting like business aerospace is going through, it is good to have a $70 billion backlog of protection orders to fall again on. A lot of that’s because of Raytheon, which is a number one supplier of missiles, sensors, and electronics for the Pentagon.

Gross sales from the legacy Raytheon facet of the enterprise jumped 6% within the first quarter, pushed by a 15% bounce in its house and airborne techniques unit and an 11% achieve in its missile protection and superior electronics unit. The enterprise additionally ended the quarter with a robust 1.46 book-to-bill ratio — that metric measures of the amount of latest orders coming in in comparison with what went out the door. Missile techniques was the large driver of that, with a book-to-bill ratio over 2.0.

Missiles additionally gave the mixed firm its first large protection win, with Raytheon Tech on April 17 beating out Lockheed Martin for the contract to develop the Air Force’s new Long-Range Standoff Weapon. That is a cruise missile program price upwards of $10 billion within the years to return.

Illustration of a a Raytheon missile launching from a destroyer.

Picture supply: Raytheon Applied sciences.

Raytheon Applied sciences has suspended most steerage for 2020 as a consequence of COVID-19 and its influence on airways, however the firm nonetheless expects to generate optimistic free money move for the 12 months because of its protection enterprise.

The legacy United Applied sciences enterprise contributed about $24 billion of the mix’s $26 billion in whole debt on the time of the merger. With business aerospace money move anticipated to be breakeven at finest, it appears unlikely the corporate’s strong 4% dividend yield can be secure absent the merger.

Raytheon Applied sciences has stated it stays dedicated to the dividend, with Hayes telling buyers on Could 7 the corporate has “enough money and liquidity to take care of a aggressive dividend even on this very tough setting.” For that, buyers have protection to thank.

A survivor, however not but a purchase

Within the April 14 memo to staff, Hayes continued to speak up the stability of the unified portfolio, saying the “strong energy” of the protection enterprise “will assist protect the corporate total.” For legacy United Applied sciences shareholders, together with many who were against the deal when it was announced, that protect should really feel fairly reassuring.

For legacy Raytheon holders, the deal with the worth of diversification is probably going bittersweet. However it’s price noting that shares of Raytheon Applied sciences have held up effectively of their first month of buying and selling, nudging out protection heavyweights Lockheed Martin and Northrop Grumman. And protection buyers solely want to return a couple of years to recall a time of Washington budget battles and sequestration, when Pentagon contractors badly underperformed business aerospace firms.

I am of two minds about Raytheon Applied sciences shares, which is maybe comprehensible on the subject of an organization working in two sectors with divergent cycles. For an investor searching for publicity to business aerospace, RTX is a solid option now because of the robust protection enterprise. However for these searching for investments amongst protection firms, there are better options that do not have a business aerospace albatross weighing them down.

I am a giant believer within the energy and potential of the Raytheon Applied sciences portfolio, and the dividend will make it simpler for shareholders to journey out this storm. However for now, I see higher alternatives elsewhere for my investing {dollars}.

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