United Technologies

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 3/5

United Technologies, or as known today RTX, is an Aerospace and Defense company that is primarily a supplier to commercial and military sectors for aircraft.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: United Technologies, now known as RTX, is a major player in the aerospace and defense industry. It’s important to note that most of the recent financial data and the earnings calls refer to “RTX” rather than UTF, as the rebranding to RTX happened in July of 2023. The company operates through several key segments:

Collins Aerospace: This segment provides a wide range of advanced aerospace products and aftermarket services to both commercial and military customers. It deals with avionics, aerostructures, interiors, and power and control systems.
Pratt & Whitney: This segment is primarily engaged in the design, manufacture, sale, and support of aircraft engines for both commercial and military use. They’re known for their innovative engine designs like the Geared Turbofan (GTF) engine.

Revenue Distribution: RTX generates revenue from a mix of commercial and military sales. This mix can vary significantly from year to year depending on market cycles. Here’s a rough distribution:

Commercial Aerospace: A significant portion of revenue comes from the sale of aircraft parts and systems, and aftermarket services to commercial airlines. A good portion of the profits also comes from after sales services from their installed base.
Military Aerospace: A large amount of revenue is generated by selling products and services to government defense agencies and contractors. Both commercial and military revenues rely heavily on a long term cycle of aircraft maintenance and replacement.

Industry Trends

Increased Defense Spending: Geopolitical tensions and increased global defense spending have created tailwinds for the company’s military side.
Demand for Air Travel: Despite economic uncertainties, there has been increased demand for air travel, pushing the airline sector to purchase more planes. This has impacted both commercial and business jets.
Supply Chain Challenges: Like the rest of the manufacturing world, the aerospace industry has been affected by supply chain issues and labor shortage, leading to higher costs and production bottlenecks, particularly for new engines and aircraft. These issues were noted by RTX management during multiple recent calls.
Sustainability: There is increasing pressure on aerospace companies to make the industry more sustainable. Companies are increasingly focusing on reducing carbon footprints, developing greener technologies, and sustainable aviation fuels.

Competitive Landscape

Aerospace: This market is highly concentrated, with a few major players such as Boeing and Airbus. In some areas, they compete directly, but sometimes they are partners. The aerospace industry has very high barriers to entry as the technology and capital requirements are quite high.
Engines: This is another highly concentrated industry, with GE Aviation, Rolls-Royce, and Pratt & Whitney dominating the landscape. There is some competition for various aircraft programs, with the need to innovate and keep ahead of the competition.
Intense Competition: Both segments of their business face intense competitive pressures because of strong competition from incumbents and new entrants. New technologies can also disrupt their business.
High Switching Costs: The high costs and lengthy qualification process for replacing aircraft systems or engines make switching to a new supplier very costly. This creates high switching costs for the company’s customers.

Moat Analysis: Based on the business analysis, RTX does possess a moderate moat (3/5), mostly driven by:

Intangible Assets (Brand & Patents): Pratt & Whitney has a strong, established brand recognition in the aircraft engine market, specifically with GTF engines. Furthermore, they are reliant on patents and R&D. On the Collins side, they have a strong reputation in the aerospace market. They also use proprietary technologies and intellectual property, which makes their products hard to copy. However, patents and technologies are always subject to being surpassed.
Switching Costs: The long-term nature of aircraft development, and high reliability and certifications required, makes switching to another supplier difficult and costly for its customers. This provides the company with considerable pricing power and protection from competition.
Barriers to Entry: The aerospace and defense industry has high barriers to entry due to the considerable capital investment, technical know-how, and established customer relationships required to compete.
Long Cycle of Contracts: Because of the long testing and certification process, contracts are long and very sticky. Furthermore, the business model is set up in a way where after sales revenue is high and very lucrative.

Risks to the Moat: Despite the moats above, the company’s business also faces significant risks that may erode their competitive position:

Technological Disruptions: Rapid technological changes, such as electric aircraft, alternative fuel sources and autonomous flights, pose a long-term threat. Any major shift might force RTX to spend more money and resources or risk getting behind.
Supply Chain Issues: These have been a major problem for RTX, affecting production schedules and timelines. Ongoing issues could weaken the company’s ability to deliver products and could be bad for its customer relationships.
Government Regulations: The aerospace and defense industry is heavily regulated, which means any change in regulations, especially with defense contracts, can have a significant impact on the business.
Cyclical Industry: Demand for commercial air travel is tied to overall economic conditions, which can introduce volatility to revenues and future performance. Additionally, a reduction in defense spending would materially affect that portion of the revenues.
High Capital Investments: It takes a significant amount of capital to sustain the manufacturing process and development for both aerospace systems and engines. If these capital investments do not produce good results, the company could be in a precarious situation.

Financials:

Revenues: RTX has shown positive revenue growth over the past couple of years with growth in commercial and military sales, although they have seen a few headwinds from supply chain issues and the effects of the pandemic. A significant part of the increase in revenue has been a result of the recent Collins & Pratt and Whitney acquisitions.
Margins: Operating margins have decreased during the past couple of years, primarily due to rising costs and supply chain problems, along with acquisitions-related costs, but they show signs of stability in the latest earnings reports.
Debt and Liquidity: RTX has a moderately high amount of debt, and may have a hard time when it comes time to refinance. While they have enough liquidity currently, higher interest rates may affect their debt servicing abilities and profitability. In addition, acquisitions have not been completely digested and some debt issues may still be present.
Free Cash Flow: Though free cash flow has remained positive, the high capital expenditure required to fuel innovation in its business can reduce that cash in hand.
Share Buybacks: RTX has been engaged in buybacks of its shares in order to reward shareholders. While this is welcome, it can become a problem in the future if those shares were bought with high debt and at high price-and then there is the possibility of diluting the shares through new issues.

Recent Concerns and Controversies:

Supply Chain Issues: These issues in the aerospace industry are well known and have been affecting delivery times and costs for a while. The company is working with its supply chain to optimize operations.
Inflationary Pressures: The increased prices are affecting input costs, putting downward pressure on their operating margins. The company has responded by raising its prices, but it remains to be seen how much that will help.
RTX Rebranding: The rebranding of United Technologies to RTX has caused confusion and many reports still label the company as UTF, so it will take time before the change takes hold.

Understandability Rating: Based on complexity, the business’s understandability is rated as a 4/5. Though they sell in aerospace and defense, which are industries hard to grasp for a non-insider, their business model can be explained using very simple words: they develop complex tech, sell it, and then provide ongoing maintenance. What makes the company somewhat difficult to understand is the high number of divisions and subsidiaries along with the complicated nature of their products. Furthermore, their customer dynamics (government vs. commercial) can sometimes get confusing. Overall the main things are easy to understand, but getting deep into the business can become hard for a non-specialist.

Balance Sheet Health Rating: RTX’s balance sheet receives a rating of 3/5. While the company has enough short term and long term liquidity currently, it has a decent amount of debt to deal with. The company also has a lot of goodwill that was generated from previous acquisitions, which is an intangible asset with not much value if the company’s performance declines. While there is no immediate danger, the amount of debt on their balance sheet is something to watch, especially with the current macroeconomic environment. The company also has to consider new accounting rules for pensions and post retirement benefits.