RTX Corporation (NYSE:RTX) Morgan Stanley’s 12th Annual Laguna Conference Call September 11, 2024 2:45 PM ET
Company Participants
Chris Calio – President & Chief Executive Officer
Conference Call Participants
Kristine Liwag – Morgan Stanley
Kristine Liwag
Great, everyone, let’s get started. Hi, good morning. I’m Kristine Liwag, Morgan Stanley’s aerospace and defense analyst. I’m very excited to have our next panelist up on stage, Chris Calio, President and CEO of RTX. Thanks, Chris.
So, before we begin, standard disclosure that you’ll memorize at the end of day. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative.
And I’m sure, Chris, you’ve got your own disclosures.
Chris Calio
Yeah, I’ve got my own that I’ve got to do. Thank you, Kristine. I’ll just say, obviously, I’ll probably be making some forward-looking statements today and there’s some risks and uncertainty associated with that and please consult our SEC filings to learn more about that.
And then, maybe just to get us rolling, Kristine, here, and then I’ll sit through your interrogation here, right, is to say, look, we feel really good about the performance in the first half of the year. Feel really good about the performance across all of our three business units and the trajectory that they’re on. We’re still tracking to the full year guidance that we’ve outlined for the year, so feel good about that.
And then, the story for RTX is really one of demand, demand on the commercial aerospace side and tremendous demand on the defense side given the environment out there today. And so, our focus each and every day is on executing on that demand. We’ve got a $206 billion backlog, again, healthy on both the commercial and defense side, and we are focused on executing that for our customers at the cost, at the quality and on time. That’s where our focus is as a management team.
Kristine Liwag
Well, great. Great to know that there’s no change to the financial outlook for the year.
Question-and-Answer Session
Q – Kristine Liwag
So, maybe, Chris, lately you’ve talked about your strategic priorities, now that you’re CEO of the company. Can you talk more about this and other focus areas you’ve been spending your time on?
Chris Calio
Sure. On the Q2 call, outlined kind of the three key priorities that each and every day we wake up focused on. One is it kind of builds off of what I just said at the opening, executing on our commitments, okay? I mentioned the $206 billion backlog. Our products are in demand, both on the commercial and the defense side. So, for us, what does that mean? It’s focusing on our core operating system, our operating system that has the lean and continuous improvement tools, making sure that we’re improving quality, delivery and the like.
I’m working on our supply chain. Again, supply chain, everyone has been talking about the supply chain. We continue to see steady [Technical Difficulty] there, Kristine, but we’re not necessarily where we need to be, but we’re seeing quarter-over-quarter improvement and need to keep the focus there.
And then, capacity, we’ve got to continue to build capacity to meet the ramp. We’ve talked at length about the capacity we’ve put in on the GTF MRO network, I’m sure we’ll talk about that later, but also on the defense side. We’ve made investments in Camden, Arkansas, in Alabama, on the Raytheon side and Spokane for the carbon, wheel and brake business. So again, continuing to build the capacity needed to meet that.
Second priority would be innovating for future growth. As you all know, we are in a long-cycle [Technical Difficulty] on both sides of the business. And if you’re not continuously investing, you may miss a cycle. And if you miss a cycle in these businesses, you get shut out of some very lucrative business for decades. This year alone, we’re going to invest about $7.5 billion in terms of customer and company-funded E&D. We’ve got 14 cross-technology roadmaps that have specific funding levels; TRL, technology readiness level goals; when do we need those to be ready for the next-generation platforms, in addition to just the technology developments, the investment in innovation and how we design our products and how we build our products.
We’ve talked at length about our connected factory initiative. There’s so much data coming off our equipment. We need to continue to understand where we have issues, making sure that we increase equipment uptime. We’ve connected 26 factories year-to-date, be at 40 by the end of the year. So, innovating not only in terms of the product portfolio, but also a factory in our digital footprint.
And then lastly, it’s continuing to leverage the scale and breadth of RTX. And so, what does that mean? When RTX came together in 2020, it was now a pure-play focused aerospace and defense company. We have significant synergies, both cost and technology. And so, how do we continue to realize those? There are plenty of opportunities for us. I think I’ve mentioned one recently. If you just look at our procurement spend, about 35% of our procurement spend is common amongst all three business units.
So, how do we go better leverage that for instance? And how do we make sure that the technology roadmap that I just talked about, which is relevant to all three business units is being executed in a way till we make sure that we share technology from one business to another to offer our customers the best products. And so, it’s both on the technology side, but also on the cost side, interrogating all of our cost pools today, where can we do things more centrally as opposed to in each of the business units to drive better cost and better performance.
Kristine Liwag
Thanks, Chris. And maybe digging deeper into the innovation and technology that you highlighted, can you talk more about what’s happening in the next-gen propulsion activity? You’ve had some demonstrator activity. And what’s going on there? And also the GTF advantage, any color on these programs would be helpful.
Chris Calio
Yeah. Next-gen propulsion, let me talk about three particular areas, Kristine. On the commercial side, we’ve got the hybrid electric demonstrator, that’s a collaboration between Collins and Pratt, that continues to show the benefits of hybrid electric and we see that initially penetrating what we would call like the smaller aircraft segment, more in that Pratt Canada level segment, but ultimately maybe translating into next-gen single-aisle maybe as a hybrid assist or at some corner points. So, we continue to invest in that collaboration.
You mentioned GTF advantage. Of course, we’re going through the development and certification process right now. At the end of the day, that’s going to get 4% more thrust and another 1% in terms of fuel efficiency. What I will tell you we’re really, really focused is on the durability of that engine coming out of the box. We have learned our lesson from the prior iterations of the GTF. We want to make sure when this engine comes into service, the time on wing, the [LOP lives] (ph), all the things that the airlines want to see and that we want to see in terms of the financial returns are there.
And then, I would say, on the military side, it’s the engine core upgrade on the F-135, right, which is all about continuing to keep the F-35 relevant as it moves into the high-end fight. We’ve gotten through the initial preliminary design, had done very well, very good customer feedback. So that program continues on its way again, keeping the F-135 on the F-35 platform well into the future.
Kristine Liwag
Thanks, Chris. And then, you kicked-off your remarks with the demand picture, but let’s dig a little deeper into the macro backdrop. Can you talk about what you’re seeing in aerospace and the defense end markets? What are the key drivers of growth and key items to watch?
Chris Calio
Sure. Why don’t I start on the commercial side, Kristine, okay? So, let’s start with OE rates, maybe a little more near term. Obviously, the demand is there. I think if you look at the Airbus and Boeing backlogs today, it’s like 14,000 aircraft. The demand is there. We are still like many in the industry calibrating with Boeing on what the rates are for ’25 and beyond. Obviously, we’ve got a lot of capacity above and beyond what those rates are today. So, it’s making sure that we’re calibrated to where that’s going and that we’ve got the right level of inventory to support that and we’re also not bringing in excess inventory.
I would say on the Airbus and Embraer side, mostly because of Pratt, aligning on — continue to aligning on the allocation between installs to Airbus and airframers and Embraer and the support that we need for the fleet given the GTF fleet management program. So that’s spare engines and material for MRO. But if you just step back a little bit longer-term on OE, just there’s going to be continued demand. I mean, we see 3% to 5% annual RPK growth. If you look at the reports that have come out from the airframers, you’re going to need upwards of 40,000 new aircraft over the next 20 years. So, the demand is there. We believe we’ve got the products to continue to fulfill that demand.
Commercial aftermarket, obviously, a big driver of our profit, a big driver of our 2025 cash plan, I would say, continues to be strong. And there’s been some gaudy numbers out there the last few years, right? I think we had 23% year-over-year growth last year, 11% in the first quarter, 14% in the second quarter, and that’s going to start to normalize a bit as the compares get tougher, but the demand is still there. And if you just step back and look at the underlying fundamentals of our commercial aftermarket, they’re really, really strong.
Take Collins. Collins has $100 billion worth of its installed base that’s out of its warranty period. Take a look at Pratt & Whitney Canada, which we truly believe is the premier small engine franchise in the industry. They’ve got about 68,000 engines in service, about 90% of those are out of their initial warranty period. And then, of course, if you look at Pratt, everyone knows the GTF, but the V2500 continues to be a very strong platform for us and for our customers. About 20% of that fleet hasn’t yet had its first shop visit and about 60% of that fleet hasn’t had its second shop visit. So, just a lot of aftermarket tailwind associated with those programs. So very, very strong.
On the defense side, okay, I think everyone understands the global demand picture and how strong it is. And our products are absolutely pivotal to the US and our allies. I’ll just give you a statistic to sort of bring this home. If you think about the April 13th attack on Israel, 86% of the UAVs and the cruise missiles that were intercepted during that, were intercepted using Raytheon products and effectors. So, the Raytheon product portfolio is essential to the US and our allies.
If you look at where that spending is going to continue to come from, Kristine, obviously, we’ve got replenishment from the US and our allies. You’re seeing NATO clearly start to get up to those 2% commitments more across the board than they ever have been. You’re seeing the Middle East region continue to spend in INDOPACOM, think of Japan, Australia, South Korea. So, the demand just because of the global picture and the threat environment continues to grow there.
If you just think about Raytheon in the third quarter, thus far in the third quarter, we’ve got about $8 billion of bookings. And if you go break that down, it’s very clear that people need integrated air and missile defense. That is the key to a lot of what’s happening out there today. And Raytheon is supremely positioned in that area. And if you think about Patriot, NASAMS, GEM-T, AMRAAM, Coyote, counter-UAS, which continues to grow in prevalence given the threat environment. So, very, very strong demand there.
I would also say on the Raytheon front, they’ve got a number of what we would consider to be future franchises in the pipeline. Think LTAMS, which is the next-gen Patriot radar, which has 360-degree sensing capability. We’re going to continue to make enhancements to existing platforms and do tech refreshes to add capability to respond to some of the threats that we’re seeing out there that we’ve seen in the Ukraine conflict. So, think AMRAAM. We’re going to continue to add capability to Coyote, the counter-UAS, because we continue to learn more in the field. And also say hypersonics, our HACM program continuing to invest in there to extend our leadership in hypersonics.
So, a fantastic installed-base that I would say meets the moment today, but also franchise programs in the pipeline that are geared towards those advanced threats.
Kristine Liwag
So, Chris, just wrapping up on defense, it sounds like you’ve got solid activity with the $8 billion of orders in the quarter, but you’ve also got visibility into additional programs that would create a positive inflection point. Is that fair?
Chris Calio
Yeah, as I said, just think of — as I said, I’ll pick on LTAMS again. The 360-degree sensing capability is something that is going to be a huge enabler for the US and our allies, right? And that’s just starting to come into production. And there are some other programs, LRSO, long-range strike, that’s also going to start coming out of development into production. These are the next-generation advanced capabilities. Again, this is a long-cycle business as I said upfront. We’ve got to continue to invest so that you’re ready to meet the needs of the market and Raytheon has done that.
Kristine Liwag
Great. So maybe pivoting to Collins Aerospace, you had recently a change in leadership. How should we take that into context? Do we — do you expect to see a change in strategy as well? And then, also, for Collins, you’ve got pretty good profit year-to-date so far and cost reduction is a key initiative in terms of getting higher earnings power in the future. Can you talk about additional levers for Collins Aerospace going-forward?
Chris Calio
Yeah, I would say, no change in overall approach to Collins. Again, as I said upfront, pleased with how they’ve started the year, about 9% organic sales growth, another 150 basis points of margin expansion. So, off to a very, very good start.
When you talk about Collins, you have to start with its product positioning and the investments they’ve made. They have 2x the content on the new-generation platforms versus the older platforms. And that translates into, obviously, strong OE growth, but also that continued aftermarket growth that I mentioned upfront, the $100 billion of out-of-warranty installed base. So, they’re on premier programs. They’ve got significant positions on those programs and that translates into aftermarket.
To your point, I think there’s also some cost runway at Collins. If you just think about how Collins was ultimately created, just kind of go back to the beginning, you had Hamilton, then Goodrich, then Rockwell. Rockwell had just acquired BE and then comes into the United Technologies family at the time. That’s a lot of integration, and lot of that is still ongoing and there’s still runway there.
I would say, we’ve — Collins has removed about 14 ERP systems since then, they’re moving almost 3 million hours from higher cost to lower cost. They’re setting up centers of excellence where they can do things like electronics in one location that feeds all of its business units. So, I think that’s again another enabler.
I would also say OE rates as they continue to rise. I said upfront that Collins is capacitized for perhaps higher OE rates than we’re seeing today just think back to 2019. So, as OE rates continue to rise, you’re going to see more productivity in the shops and better absorption as well. So, all things that I think are tailwind for Collins.
Kristine Liwag
Great. Thanks, Chris. Switching gears, pun intended, to the geared turbofan.
Chris Calio
Yeah.
Kristine Liwag
As you know, a geared turbofan question would be expected at this point.
Chris Calio
Yeah, I thought it was going to be number one, right?
Kristine Liwag
I tried to put in the middle.
Chris Calio
Yeah, thank you.
Kristine Liwag
How is the fleet management plan going? And what KPIs should we watch? How is the program progressing?
Chris Calio
Yeah. No, thanks, Kristine. Again, no new news since we kind of laid this out in our Q2 call, but I’ll just sort of reiterate. No change to the financial or operational assumptions that we laid out last year that we report on our earnings, I would say. Just start from the top, it always starts with safety. We’ve done over 6,000 inspections and our inspection findings and the fallout rate are entirely consistent with what we had assumed they would be. So that’s great news.
No change to our AOG peak or average during the period. No change to the turnaround time assumptions that are in the period. And our customer support agreements continue to be in-line with our assumptions as well. Now, the single biggest enabler because we get asked a lot, like what can make this — what can change the trajectory here. Single biggest enabler is MRO output.
I was down in Columbus, Georgia last week at our GTF MRO shop, which is frankly one of the better shops within the overall GTF network. And we are doing everything we can to take time out of each of the gates, right? Gate one, disassembly. Gate two is where you accumulate your material. Gate three, reassembly. Gate four, test. Of course, the long pole in the tent right now is that gate two, material accumulation. While we have seen significant uptick in receipts and structural castings and in forgings, the demand is still huge as you might imagine, because you need those parts for other parts of your programs as well non-GTF.
So, again, we continue to fight through what I would say material flow. When we have material, our network has shown an ability to really compress turnaround times. We’ve seen significant reductions in the other gates where you’re more in control of your own destiny. You’re not waiting necessarily for material repairs to come back. And we continue to use our core operating system to take hours and days out of each of those, so that when we do have the material, we can turn those engines very quickly.
So, while there are no changes to our assumptions, just know that each and every day, we are looking for opportunities to accelerate getting support to our customers as quickly as we possibly can.
Kristine Liwag
Thanks, Chris. And outside the GTF, focusing back on Pratt, you touched a little bit on what you’re seeing in the military activity in the V2500. Can you talk more about the drivers of earnings there and how we should think about their contribution to the segment?
Chris Calio
Yeah, I thank you for teeing that up because when we talk Pratt, we have a tendency just to talk GTF. There are, first of all, other parts of the large commercial engine business, and I talked about the V2500. I won’t reiterate that, but just know that we’ve seen very, very few retirements in that fleet that is going to continue to be a very strong contributor of aftermarket sales and profit well into the future. I think we had given some guidance this year for about 800 shop visits and we’re on or about on the trajectory to meet that. So, it continues to be very strong.
Pratt Canada is probably a business we don’t talk enough about, Kristine. I talked about it little bit upfront, but if you just look at the fundamentals of that business, they are number one or number two in virtually all of their segments. They’re on — sole-sourced on over 200 platforms, 68,000 engines in service, just a phenomenal installed base with strong positions that are going to continue to yield aftermarket returns well into the future and a very strong first half on the aftermarket front.
And then, on the military engine business, of course, everyone knows about the F-135 powering the F-35 and I mentioned the engine core upgrade, keeping that as the engine on the F-35. But it is also on other priority platforms, think B-21, think Tanker, F-22, things that are relevant for the fight in the future, but also relevant to today. So, very strong franchises across the other pieces of Pratt.
Kristine Liwag
Great. And let’s pivot back to Raytheon Defense.
Chris Calio
Great.
Kristine Liwag
You’ve got a pretty good start of the year, 10% organic, still — I guess, good organic sales growth, 10% margin in the second quarter, but you’ve got a $51 billion backlog. What are the key obstacles for you in terms of delivering more — converting this backlog into revenue? And what are the obstacles for getting margins higher than that 10%?
Chris Calio
Yeah. So, yeah, as you said, the strong start to the year for Raytheon like the trajectory we’ve seen there in terms of the margin expansion and the like. Again, the story with Raytheon starts with demand. The rolling 12-month book-to-bills of 1.13, you mentioned the $50 billion backlog. I mentioned the orders we’ve got here already in Q3. So, incredible demand.
So, for Raytheon, it is all about productivity, material flow, and then getting, I would say, our development programs through some key milestones. And we’ve talked about that over the last year or so. So, if you start with material receipts, we’ve seen five straight quarters of growth in material receipts. That’s fantastic. That means your shops are getting the material they need, they can turn product. In many cases, they can shorten their period of performance when they’ve got the material. That’s where you see some of those productivity gains, right?
The capacity that we continue to add, I mentioned the capacity we’re adding in Arkansas and in Alabama. We are taking the Coyote production up significantly this year given the heightened threat environment and the threat that, that addresses. So, again, supply chain capacity.
And then, again, we’ve got some development programs and we’ve talked about them. There’s a handful that we need to continue to get through the development milestones and ultimately into production. I would say that we continue to have line of sight to reaching those. But again, once those can get through, and in some cases, those were programs where we’ve struggled a bit, but I think we’ve battled back and now have line of sight to seeing those through and removing those, if you will, as a headwind.
So, again, the name of the game at Raytheon is how do you execute on that demand and how do you execute on that backlog. So, material, capacity, and then, of course, our development programs.
Kristine Liwag
Thanks, Chris. And going back to the RTX level, you guys have put out $36 billion to $37 billion of capital return that you’ve reaffirmed. How do we think about your strategy on capital return? What are the priorities here?
Chris Calio
Yeah. I think you’ll see a consistent posture on capital allocation. So, thank you, the $37 billion — $36 billion to $37 billion by ’25, still committed to that. I think the ASR that we’ve done has been very well-executed. You and I talked about that offline a little bit and we are continuing now to meet our commitment on deleveraging and paying down some of that debt. We remain committed to a growing dividend, growing with earnings. And then, the last piece that I think has probably been more of the UTC story, which was some of that transformative M&A. I don’t necessarily see that for us here at RTX.
I mean, if you think about the portfolio that we put together, I think it’s a fantastic portfolio as I’ve said throughout this discussion today. So for us, that’s not about adding transformative pieces. It’s probably just more around pairing the portfolio, pruning it a little bit to make sure that everything that’s in there kind of — as we kind of set-up our filters for what it means to be an RTX business, meets that criteria where we see opportunities, we had one in the second quarter in our hoist and winch business. Again, some of these are smaller pruning opportunities. We’ll take them, because, again, continuing to focus the portfolio, I think, will just enhance our ability to drive returns.
Kristine Liwag
Great. And maybe looking at the portfolio, I mean, you touched on this. You’ve seen a lot of changes in the previous UTC aerospace business, Goodrich, Rockwell Collins, the Aerospace, and there’s also the integration with Raytheon Defense. I mean, the past few — plus you’ve got COVID somewhere in there, too. So, there’s been a lot of disruption and there’s a lot of integration going on with the company. Can you give us an idea what’s the state of the portfolio today? Where are you in this integration journey? And ultimately, what do you think is an underappreciated piece of the RTX investment story today?
Chris Calio
Yeah. No, thank you. I would say, we’re not here to complain about COVID, but the deal was consummated in COVID. So, if you think about bringing together one of the largest aerospace and defense deals in the middle or right at the beginning of COVID, hampers integration a little bit. We weren’t able to see one another collaborate as effectively perhaps as we wanted to. So, it took us a little bit of time to sort of drive that integration. But I would tell you, we absolutely accelerated and caught up.
Cost synergies met and raised, continue to identify technology synergies. And I will tell you that the focus now is less on integration and more on execution. We, obviously, did our four to three combination where we move pieces of Raytheon into Collins, pieces of Collins into Raytheon to make sure that we were better matched up with the markets and the opportunities, that is behind us. And so, we really — feel really, really good about where the portfolio is and where the focus is.
You mentioned underappreciated. Again, we’re not the kind of people that take out our violin and complain about how we’re perceived necessarily. I would just say that the portfolio in our view is compelling. And again, I’ll reiterate it a little bit because we really truly believe this. You take Collins, it’s number one or number two on 70% of its product portfolio. It’s got significant positions on 110,000 aircraft. I mentioned it few times now, but it’s worth repeating the $100 billion of the installed base that is out of warranty.
Pratt, you’ve got, of course, a very strong GTF backlog, still in front of us, a long aftermarket tail still in front of us, GTF Advantage that’s going to be coming in, V2500, Pratt & Whitney Canada, premier small engine franchise, and then a military engine business that’s on all of the priority programs. Then, you look at again Raytheon, I’ll say it again, it really meets the needs of today and the threats of today. It’s got premier sensing, ISR and effector technology in portfolio.
And then, when you step back and say, okay, how do we make sure that we pull that all together effectively? We spend a lot of time focusing on what I would call the connective tissue, our core operating system, making sure that we’re going into our facilities and doing the type of continuous lean activity.
Matter of fact, I was just down in Forest, Mississippi, working on a core project with the team there on how do we increase rate, how do we redesign the cell to make sure that we can increase rate, make it easier for the operator, improve first pass yield. These are all the things that we are focused on across the portfolio, our digital transformation, our Factory 4.0, and again our technology synergies.
These are the connective tissue, if you will, Kristine, that I think will enhance what we consider a compelling portfolio. And I think at the end of the day, we think this portfolio is in a position to generate significant cash to be able to invest and reinvest, as I said upfront, because it’s a long-cycle business, but also be able to drive returns to our shareholders.
Kristine Liwag
Great. Thanks, Chris. And we’ve got time for one last question. So, maybe circling back on some of the innovation technology items you talked about earlier, which one of these initiatives are you most excited about?
Chris Calio
Yeah. We’ve got a number, I’ll just — instead of going through maybe the 14-point technology roadmap, maybe just sort of domain areas, sustainability on the commercial side absolutely both Collins and Pratt. I would say advanced propulsion both in commercial and in military, connected battlespace and resilient networks, how do we continue to connect our allies in denied environments? And you’ll see that as between Collins and Raytheon.
And then, there are just a number of what I would call enabling technologies that we’re working on across all three businesses, Ceramics matrix composites, for instance, other ways that we can distribute and dissipate heat in all of our applications. We’ve got 60,000 engineers across Raytheon working on these problems and we’ve also got a centralized research center that helps prioritize these and make sure that they have broad applicability across the portfolio. So, we’re really, really excited about the technology portfolio and the tailwind we think it’s going to provide.
Kristine Liwag
Well, great. Thank you very much, Chris. Thank you for joining us today in this lovely Laguna location.
With that, this concludes our presentation in RTX this morning. Thank you, everyone.
Chris Calio
Have a good day. Thank you, Kristine.
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