A Wells Fargo analyst recently added RTX(NYSE: RTX) to a list of "tactical ideas" for the second quarter. The analyst maintained the company's price target of $120 and an overweight rating on the stock. That would imply a 22% upside on the stock over the next 12 months or so.
GTF issue
The renewed enthusiasm for the stock is related to RTX's ongoing problem with its Pratt & Whitney geared turbofan (GTF) engines. As a reminder, Pratt & Whitney found a potential contamination issue in the powder coating used on turbine discs in GTF engines.
In September, RTX management told investors that the "majority of incremental engine removals will occur in 2023 and early 2024." As such, it seems likely that management will be able to give an even more solid estimate of the final cost of the inspections during the subsequent quarterly earnings.
As such, the issue may be fully priced in, and removing uncertainty could lead to some upside potential for the stock. This will help, but there's no guarantee that management's update will be positive.
Defense margins
The analyst's suggestion that defense margins will increase in the future is also open to debate. Margin pressure has affected other major defense contractors like Boeing and Lockheed Martin. It's unclear whether this is a temporary issue that will improve as raw materials become more available and supply chain issues are resolved.
Alternatively, it could be a structural problem arising from, in the words of Lockheed Martin CEO Jim Taiclet, governments "taking advantage of that monopsony power, if you will, over the industry" or even rising geopolitical tensions making it harder to procure defense materials from certain parts of the world.
Whatever it is, until defense contractors can start demonstrating margin expansion, the questions will remain.
Image source: Getty Images.
A stock to buy?
RTX is an attractive stock, but investors who value certainty will probably want to see what management says about the GTF inspections issue and some evidence of margin expansion among defense contractors before initiating a long-term position in RTX.
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Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Lockheed Martin and RTX. The Motley Fool has a disclosure policy.
