Morgan Stanley downgraded Raytheon Technologies (NYSE:RTX) to an equal-weight rating (From Overweight) and cut their 12-month price target on the stock to $95.00 (from $110.00) after the aerospace and defense company reported an unexpected manufacturing defect during their 2Q earnings report.
RTX saw a drop of 10.2% in their share price on Tuesday, following the disclosure of a manufacturing flaw associated with the Pratt & Whitney high pressure turbine (HPT) discs used in the Airbus A320neo Geared Turbofan (GTF) engine. The defect traces back to contaminated powdered metals produced from 2015 to 2021, impacting the functioning of the HPT discs in some engines shipped from the fourth quarter of 2015 through the third quarter of 2021. However, RTX assured that they have enhanced the manufacturing process since 2021 and that the HPT discs being manufactured presently are defect-free.
“The underperformance of the stock reflected the unexpected negative surprise regarding the manufacturing defect of the Pratt & Whitney high pressure turbine (HPT) discs,” wrote analysts.
“In our view, the risk of unknown unknowns of the GTF could weigh on sentiment in the near- and medium-term especially considering the teething issues of the engine in its early years, the durability issues highlighted at the Paris Air Show (link), and this new HPT disc issue,” they added.
RTX anticipates that around 1,200 PW1100G-JM engines will be impacted by this defect. Corrective measures would involve detaching the engine from the wing of the affected models, disassembling the engine, extracting the HPT disc, carrying out a comprehensive inspection of the component, replacing the defective part, reassembling the engine, and finally reattaching it.
RTX has not released any information on the cost impact of the 1,000 engines that need to be inspected. If the costs are lower than updated estimates post 2Q23, upward revisions in earnings could create a positive catalyst. However, costs depend on how many engines are already scheduled for a check-up in 2024 and how many will need a quick engine visit. Also, costs depend on the duration of the engine visit as Pratt may be required to make airline customers “whole” depending on specific contract terms.
Morgan Stanley cut their 2023 adjusted EPS estimate to $4.95 from $5.00 and lowered FCF estimates to $4.1 billion from $4.9 billion. Revenue estimates were relatively unchanged as Morgan Stanley factors in a potential headwind to revenue of ~$750M as a result of the agreement reached to divest Collins' actuation and flight control business offset by better core growth. 2024 EPS estimates were cut to $5.85 from $6.05.
Shares of RTX are down 0.68% in early trading on Wednesday.