Raytheon Reports 1Q 2020 Results; Maintain BUY and $78 Fair Value Estimate

• On May 7, 2020, before the market open, Raytheon Technologies Corp. (NYSE: RTX) released 1Q 2020 results for standalone United Technologies including Otis Worldwide Corp. (NYSE: OTIS) and Carrier Global Corp. (NYSE: CARR). As background, Raytheon completed its merger with the Aerospace business of United Technologies Inc. (formerly UTX) on April 3, 2020, following the spin-offs of OTIS and CARR. Adjusted EPS of $1.78 (-7% YoY) exceeded consensus of $1.11 and revenues of $18.2 billion (-1% YoY) reflected flat organic sales and 1% of foreign exchange headwind (higher tariffs).
• Sales at Pratt and Whitney, the aircraft engine segment, increased 11% over the prior year; Commercial Aftermarket sales increased 4%; sales at Collins Aerospace declined 1% over the prior year with Commercial aftermarket sales up 3%. Raytheon Company (the pre-merger company, and not included in Raytheon Technologies’ first quarter results), reported 1Q sales of $7.2 billion (+6.5% YoY), underscoring the stability of the defense business. Record bookings of $10.3 billion resulted in a book-to-bill ratio of 1.44. Backlog was a record $51.3 billion (+25% YoY).
• While RTX did not provide a 2020 outlook, consistent with industry peers, the results were largely a relief considering the roughly 50% decline in both commercial equipment sales and aftermarket service forecast for the rest of 2020.
• We maintain our $78 target price and BUY recommendation on RTX. The key fundamental uncertainty is the commercial aerospace business and the shape of recovery at Collins and Pratt and Whitney heading into 2021. However, despite the expectation of another weak quarter in commercial aviation in Q2, we think these overhangs are largely factored into the shares, which have declined almost 40% since January, versus 14% for the S&P 500.
• Raytheon has completed the merger with a strong liquidity position (cash balance of approximately $8.5 billion and a net debt position of approximately $25 billion). Cash flow is expected to be positive for the year, the dividend remains intact, and the defense business has been less affected by COVID issues (as demonstrated by Raytheon’s reported backlog and management’s comments surrounding a large foreign defense contract in Q2). We remain bullish on the merger rationale and long-term investment thesis, as well as key revenue drivers, including military program growth, alignment with National Defense Strategy, and continued cost synergies and cost reduction actions, which should act as catalysts for the shares.
• For more details, please refer to The Spin Off Report dated March 10, 2020, and UPDATEs dated March 13, 2020, March 30, 2020, and April 6, 2020.

Trane Reports 1Q 2020 Misses Revenue, EBITDA vs. Consensus; Lower Fair Value Estimate to $95 but Maintain BUY on Valuation

• On May 5, 2020, Trane Technologies (NYSE: TT) reported 1Q 2020 results that included revenue of $2.6 billion (down 6% versus the year prior) and adjusted EBITDA of $261 million (margins declined 150 basis point from 1Q 2019 to 9.9%).
• The lower than expected revenue and profitability was largely blamed on the global slowdown of business as Asia Pacific segment revenues were down 18% year over year while the Americas segment revenue declined just 2% (Interestingly, America’s bookings increased 11% showing signs of strength prior to the pandemic’s impact on North America despite concerns over the HVAC cycle).
• Additionally, the company did maintain its commitment to its $0.53 per share quarterly dividend. We posit that the current balance sheet (net debt of $2.9 billion with $2 billion in undrawn revolving credit lines) can support the payment through this downturn, while the dividend should provide downside support to shares.
• Further, the company highlighted cost control programs, and the willingness to implement other programs to maintain financial health through this period.
• Given the current outlook, we find it appropriate to lower our earnings and fair value estimates. We reduced our 2020 base year revenue by 10% to $12.2 billion. Under the assumption that 2021 will see somewhat of a rebound (4% increase in revenue) and margins of 15.5%, we now forecast TT to generate 1.9 billion in EBITDA in 2021. Applying a 13x multiple and accounting for $2.9 billion in net debt and 239.5 million shares outstanding, we derive a $95 fair value estimate.
• However, we maintain our BUY recommendation as we view TT as well positioned to rebound when America opens back up. Strength in the US market prior to the shutdown, focus on environmental and energy usage, along with high degree of replacement business should benefit results and allow for wider margins upon a return to revenue growth.
• Shares currently trade at 8.1x consensus 2021 EBITDA estimate, while competitor Lennox International Inc. (NYSE: LII) currently trades at 15.2x. We still expect the multiples of these two pure-play HVAC companies to converge over time while noting that Trane had historically traded at about a 2-3x multiple discount to LII when it was part of Ingersoll-Rand plc (NYSE: IR).
• For more details, please refer to The Spin Off Report dated January 4, 2020, and UPDATEs dated January 29, 2020, February 14, 2020, and March 2, 2020.

Howmet Aerospace Reports 1Q 2020 Results; Announces Cost Savings Plan of $100 Million; Maintain BUY, Lower Fair Value Estimate to $16

• On May 5, 2020, before the market open, Howmet Aerospace Inc. (NYSE: HWM) (formerly Arconic Inc.) released 1Q 2020 EPS that included a revenue decline of 9% year-over-year to $3.2 billion, and adjusted net income of $274 million, or $0.62 per share, versus $208 million and $0.43 per share in the prior year period.
• Notably, HWM’s reported results include the Global Rolled Products (GRP) business, which was spun off into Arconic Corp. on April 1, 2020. Howmet retained the Engineered Products & Forgings (EP&F) business.
• HWM’s operations appear to have fared better in 1Q 2020 than ARNC’s. EP&F revenue declined 7% (-4% organic) as COVID-19 shutdowns and continued 737 MAX delays were partially offset by increases at defense and industrial sub-segments. EP&F operating income increased 8% year-over-year to $339 million as operating margins widened by 300 basis points to 20.8% on cost reductions, lower COGS and price increases.
• GRP sales declined 12% (-7% organic) while also increasing operating profit by 25% to $169 million as segment margins widened by 320 basis points to 10.7%.
• In response to the current slowdown the company has announced a $100 million cost reduction program (separate from previously announced $50 million in savings), reduced its annual capex target by $100 million, and has temporarily suspended dividend payments (previously announced). Management expects to be free cash flow positive in 2020. Notably the company had previously targeted 100% free cash flow conversion from net income.
• We adjust our HWM earnings estimate and now forecast 2022 EBITDAP and EPS of $1.4 billion and $1.42 per share, respectively. The lowered estimates reflect a reduction in HWM’s forecasted EBITDA margin to 21% (from 22%) to reflect the current concerns on the company’s ability to drive wider margins given the uncertainties surrounding future aircraft manufacturing and fleet size to drive consumable and maintenance products.
• We revise our Howmet fair value estimate to $16 per share reflecting the lowered earnings estimates. However, we maintain our BUY rating as we continue to see upside from the current share prices. It is our belief that upon a normalization of the operating environment, even if it is a new normal with lower than previously forecasted aircraft manufacturing and active fleet size, Howmet should be able to drive meaningful earnings and cash flow improvements from what the current valuation implies.
• For more details, please refer to The Spin Off Report dated March 10, 2020, and UPDATE dated April 1, 2020.

Withdraw SELL recommendation on HE as we think the current stock price better reflects the evolving regulatory (and yield) environment

• While we think risks remain for HE in its upcoming rate cases (set for December 2020) amid an evolving regulatory environment as well as historically low bond yields, the stock has declined ~21.5% since our initiation in early-February 2020 (versus an about 10.5% decline in the S&P 500 index) and now trades toward the lower-end of our bull/bear valuation scenarios (see Exhibit #3 on page 2).
• As such, we prefer to maintain a disciplined approach and withdraw our SELL recommendation on HE, as of today’s market close.
• That said, we will continue to monitor HE for an opportunity to re-recommend (on either the long or short side) as valuation shifts or the likelihood of potential for strategic alternatives evolves.

OI reports in-line 1Q 2020 results; hits pause on the ANZ strategic review (and dividends) although its tactical divestiture program continues to “advance”

• OI posted 1Q 2020 sales down ~5% to $1.56 billion with segment operating profit down 15.5% to $169 million and consolidated EBITDA down ~9% to $274 million.  Adjusted EPS of $0.41 (compared with $0.51 in 1Q 2019) was in-line with previous commentary at the low-end of OI’s initial guidance of $0.40-$0.45.
• At quarter-end, net debt was $5.5 billion (versus $5.6 billion in 1Q 2019) and the leverage ratio, per its credit agreement, was 3.9x (vs. 4.0x at year-end and its 5.0x covenant).  Total available liquidity stood at ~$1.7 billion, including $891 million in cash.
• Full-year capex is expected to be ~$300 million (compared with the initial forecast of $300-$375 million) and OI targets year-end 2020 net debt at or below the 2019 level of ~$5 billion.
• As previously indicated, OI withdrew its initial 2020 guidance, which called for EPS of $2.10-$2.25 with sales volume being flat to up 2%. (Volume was down 0.8% in 1Q 2020 with an estimated impact of ~1.7% or ~$0.05 per share from the COVID-19 pandemic.)  Anecdotally, management expects full-year sales volume could be down 5%-10%.
• Given the current market uncertainty OI indicated that it has paused the strategic review of its Australia & New Zealand (ANZ) operation (within the Asia Pacific segment) although its tactical divestiture program continues to “advance” (albeit at a more measured pace).  As well, OI is pausing its dividend ($0.20 per share or about ~$31 million annually) and share repurchase programs (likely through at least the end of 2020).
• Our fair value estimate is reduced to $10 per share (from $10.50), reflecting a blended multiple of ~6x (unchanged) on 2021E EBITDA of $1.185 billion (previously $1.198 billion) as well as net debt, including potential asbestos liabilities, minority interest and unfunded pension liabilities, of ~$5.8 billion (unchanged).

MSG Completes Spin-Off of Entertainment from Sports; Rate Entertainment at BUY with $142 Fair Value Estimate; Rate Sports at BUY with $206 Fair Value Estimate

• On April 17, after the market close, The Madison Square Garden Co. (MSG) completed the spin-off of the Entertainment business from the Sports business. Shareholders of record received one share of Madison Square Garden Entertainment Corp. (NYSE: MSGE) for each share of MSG owned.
• Following the separation, MSG changed its corporate moniker to Madison Square Garden Sports Corp. and now trades on the NYSE under the symbol “MSGS”.
• In when issued trading, in which volume was light, shares of MSGE sold off, while MSGS traded roughly with the market. The price performance should not be totally unexpected given the current lock-down in the United States and uncertainties surrounding the near-term operational realities of both the Sports and Entertainment businesses.
• For MSG Entertainment, we moved our forecasted earnings to 2021 as we assume a return to business operations at some point in 2020 with a residual lag in business resulting in a revenue decrease of 25% versus 2019. We now model a 10% EBITDA margin and value the operating business at 7.0x, resulting in a value of $23 per share. We have adjusted the value of the owned venues to reflect the previously announced purchase price of The Forum’s estimated after-tax cash proceeds of $255.9 million, which results in the value of the owned sites of $61 per share, resulting in a sum-of-the-parts fair value of the Entertainment business of $142 per share.
• We rate MSGE at BUY and view the current depressed share price as providing significant value, albeit the timeline to realize that value is more drawn out than previously posited. We note that the Entertainment business had a pro forma net cash position of $1.4 billion as of December 31, 2020, which equates to $58 per share. While we acknowledge that the majority of this cash will be used to fund the Sphere project, given the current construction pause, the balance sheet position implies that the Entertainment operating assets are valued at $10 per share, or $240 million for a business that generated $103.9 million in adjusted EBITDA in F2019 (yearend June30).
• We maintain our fair value estimate of $206 per share for the post-spin Sports company, which is based on the published Forbes valuations for the NY Knicks and NY Rangers, adjusted for arena value, and incorporates modest growth assumptions. In our opinion, upon resumption of professional sports leagues the impact on premier team valuations should be minimal and short-lived, as such we rate MSGS at BUY.
• While we acknowledge the risk to near-term operating earnings at the entertainment business from the COVID-19 virus situation, we think that most of MSGE and MSGS’s valuation is being derived from its owned assets (both arenas and teams), which should provide a degree of stability.
• For more details, please refer to The Spin Off Report dated February 13, 2019, and UPDATEs dated August 20, 2019, November 8, 2019, December 3, 2019, March 6, 2020, March 25, 2020, and April 1, 2020.

OI sees roughly in-line 1Q 2020 performance with minimal on-going operational disruptions amid the COVID-19 outbreak; indicates strong cash flows and liquidity; we will look for an update on its strategic review during the upcoming April 29^th conference call

• OI indicates that 1Q 2020 results, which will be reported after the market close on April 28^th, will be at the lower-end of its initial $0.40-$0.45 EPS guidance, in large part due to unfavorable currency moves and higher than expected taxes. Total sales volume was down 0.8% in 1Q 2020 (compared with OI’s initial guidance of flat to up 2%) although management noted that demand fell ~7% in the last two weeks of March, reflecting weakness in Southern Europe and Latin America.
• While the company withdrew its full year EPS guidance of $2.10-$2.25 (versus our initial forecast of ~$1.75) with total sales volume being flat to up 2% (versus our initial forecast of mid-single digit declines) management indicated that most of its plants are operating with minimal disruption (i.e. 85%-90% capacity).
• As well, the company noted that 1Q 2020 cash flows improved year-over-year (on better working capital management and no asbestos-related payments) and that total liquidity was ~$1.7 billion, including $900 million of cash, at quarter-end.
• The company made no mention of its on-going strategic review, which it previously indicated was “advancing” (on March 11^th), but we expect to glean more information during its 1Q 2020 conference call, which will be held on April 29^th at 8 a.m. (ET).
• Our fair value estimate remains $10.50 per share, reflecting a blended multiple of ~6x on 2021E EBITDA of $1.98 billion as well as net debt, including potential asbestos liabilities, minority interest and unfunded pension liabilities, of ~$5.8 billion.

UTX Completes Merger with Raytheon, Becomes RTX; Revising FVE; Rate RTX at BUY

• UTX completed the spin-off of its aerospace business, which merged with The Raytheon Company on April 3, 2020. Post-merger, the company changed its corporate moniker to Raytheon Technologies Corp. and currently trades on the NYSE under the symbol “RTX”.
• On a combined basis, the company generated $74.7 billion in 2019 revenues. Assuming revenue growth of 8% in both 2020 and 2021, RTX can be expected to generate 2021 revenues of $87.1 billion. Based on an estimated EBITDA margin of 17%, RTX can be expected to generate $14.8 billion in 2021E EBITDA. Applying a 9.2x multiple to estimated 2021 EBITDA, which represents Raytheon’s 5-year historical average, generates an implied enterprise value of $136.7 billion, or $78 per share (from $65 previously) based on recent pro forma balance sheet information.
• We continue to rate shares of RTX at BUY. While Raytheon is a defense specialist focused on missiles, radars, missile defense, and electronics, it is important to note that the commercial aerospace business represented approximately three-fourths of UTX’s total aerospace sales. Given continued pressure from aircraft manufacturers Boeing (NYSE: BA) and Airbus (AIR EN) to bring down costs, Raytheon will leverage a stronger balance sheet to support ongoing aerospace product development. In addition, the post-merger company is less exposed to government and commercial sector cyclicality. The new Raytheon would rank behind only Boeing and Airbus globally in terms of total aerospace sales.
• For more details, please refer to the United Technologies Corp. Spin-Off Report dated March 10, 2020 and Update dated March 30, 2020.

Arconic Inc. Completes Spin-Off of Arconic Corp., Changes Name to Howmet Aerospace; Rate Howmet BUY with $19 FVE; Rate Arconic HOLD with $18 FVE

• On April 1, 2020 Arconic Inc completed the spin-off of Arconic Corp (NYSE: ARNC). Following the separation, the parent entity changed its corporate moniker to Howmet Aerospace Inc. (NYSE: HWM).
• Arconic shareholders of record as of March 19, 2020, received one share of Arconic Corp. for every four shares of the parent company held.
• Arconic Corp. will control the prior Global Rolled Products segment, with Howmet retaining the former Engineered Products & Forgings segment.
• Prior to the separation, Arconic Inc. was not immune to the current market volatility due to the COVID-19 pandemic, and more specifically due to the fact that as an aerospace supplier to airplane manufacturers, the current uncertainty surrounding new plane orders and builds, as well as the still uncertain timing of a resumption in the flying of the 737 MAX, are expected to pressure suppliers.
• Despite the aforementioned headwinds that are currently magnified by the COVID-19 pandemic, we think that on the other side of this crisis the main thesis likely still holds, albeit on a more drawn out timeline than was previously posited just three weeks ago. We highlight the already announced stimulus plans that include significant grants ($37 billion) to airlines, with the option for zero-interest loans, as well as significant, vocal political support for the likes of The Boeing Co. (NYE: BA).
• In terms of post-spin valuations, both companies were previously guided to generate approximately $6.9 billion in revenue in 2020, which is likely no longer to be relied upon. As such, we adjust our 2020 base revenue assumption down by 15% for HWM and 20% for ARNC. We now forecast a rebound off the lows in 2021 and expect a return to long-term growth rates in 2022.
• In addition to our earnings estimate reductions, we have tempered our valuation multiple expectations to more accurately reflect the current trading market and what we think is appropriate for the current operating environment.
• We fairly value Howmet Aerospace at $19 per share and rate it at BUY; Arconic Corp is rated HOLD and is fairly valued at $15 per share. Despite implied upside for Arconic Corp., we prefer Howmet due to the company’s balance sheet, including pension liabilities, and free cash flow profile, which approaches 100% of adjusted net income, versus ARNC in the current environment.
• Longer term, Arconic Corp. should be able to benefit from the trend of increasing use of aluminum in light vehicles and aircrafts, along with accelerating population growth, particularly in urban areas, with optionality arising from its planned re-entry into the North American packaging industry.
• Howmet is helped by similar secular tailwinds but is more likely to benefit from the aerospace industry’s backlog of next-generation planes and increasing use of aluminum structures. Absent a significant cancellation of orders, which at this point in time we have not seen, the increasing exposure to next-gen planes, with its revenue multiplier effect, should drive above-industry growth for Howmet.
• We acknowledge exposure to the Boeing 737 MAX program (previously estimated 2020 impact of $400 million) and the 2020 slowdown from the impact of the current COVID-19 virus outbreak; however, we expect a return to normal production in coming months, which should will allow longer-term investors to capitalize on the recent market pullback.

For more details, please refer to The Spin Off Report dated March 10, 2019.

LNDC reports in-line 3Q F2020 results and maintains full-year adj. EBITDA guidance of $30-$34 million; maintain $13 fair value

• In the first nine-months of F2020, LNDC posted consolidated sales growth of ~7% to 434.2 million with adjusted EBITDA of $7.9 million (versus $14.7 million in the prior period), primarily driven by strong results at Lifecore where sales advanced 17% and adj. EBITDA increased 7% to $12.6 million.
• LNDC maintained full-year F2020 guidance calling for consolidated top-line growth of 4%-6% to $580-$590 million with EPS of $0.16-$20 and adj. EBITDA of $30-$34 million.
• By segment, CF is expected to post adj. EBITDA of $12-$14 million on top-line growth of 3%-5% to $496-$504 million while Lifecore is projected to post adj. EBITDA of $21-$23 million on 10%-12% top-line growth to $84-$85 million.
• The company continues to pursue strategic alternatives for CF’s legacy vegetable bag & tray business, which generated ~$160 million of sales (but “no” EBITDA) in F2019.  Potential options remain an outright sale (with management indicating 4-5 parties in the LOI process, of which one has already conducted on-site due diligence of facilities) or a significant rationalization of the business (i.e. 50%). Ultimately, these actions, along with management’s broader operational efforts, are expected to result in a less volatile (e.g. weather) CF segment with F2021 run-rate organic sales growth of ~5% as well as gross and adj. EBITDA margin profiles of 11%-14% and 4%-6%, respectively (compared with ~10% and 3% in F2019).
• Notably, Legion Partners, an activist-investor calling for, among other things, the separation of LNDC’s “odd combination of businesses”, further increased their stake to ~8.2% during the month of March (from ~7% in February and its initial ~5% position disclosed in January 2020) at prices of $7.64-$10.
• Our fair value estimate remains ~$13 per share, based on an unchanged blended multiple of ~11x, F2021 adj. EBITDA of ~$45 million and net debt, incl. the Windset investment, of $131.5 million.