Why RTX's Engine Troubles Spell Bad News: BofA Analyst Lowers Rating To Underperform

BofA Securities analyst Ronald Epstein downgraded the shares of RTX Corporation RTX to Underperform from Neutral and lowered the price target from $95 to $75.

RTX anticipates a ~$3 billion csh headwind from 2023-2025 due to the impact on the Pratt & Whitney GTF fleet arising from the previously disclosed rare condition in powder metal used to manufacture certain engine parts.

The analyst thinks RTX will underperform the coverage universe until there is a clearer understanding of the necessary fixes, customer concessions and even organizational changes in the wake of this egregious manufacturing oversight. 

The analyst is more concerned about the non-linearity of the impact as, at peak levels, almost half of the GTF will be grounded, causing significant disruptions to operators worldwide. 

Also, the analyst noted that the published number is lower than ultimately expected as they could be used as a starting point in the ongoing negotiations, like a self-fulfilling prophecy. 

To support the argument, the analyst highlighted that Boeing Company BA took two separate charges related to 737 MAX customer concessions, with the final charge ending up 47% higher than originally anticipated.

The analyst sees many near-term risks, including higher than expected customer concessions, increased scope of engine types impacted, increased scope of subcomponents impacted, incremental reputational damage to RTX’s management team and brand, and restructuring risk at RTX’s legacy defense business.

In the analyst’s view, strength at Collins Aerospace will not be enough to balance the risks stemming from P&W and ongoing restructuring.

The price target implies 10x EV/EBITDA valuation on P&W’s 24e earnings. A 0.8x relative multiple to the market fairly balances short-term risks and long-term opportunities for GTF, said the analyst.

Price Action: RTX shares are trading lower by 1.76% at $74.23 on the last check Thursday.