Raytheon’s stock has worst selloff in more than 3 years after company says some Pratt & Whitney engines need to be removed from service

The engine business has determined that a rare contamination in powdered metal used to make certain engine parts will require accelerated fleet inspection, the company said, calling it an issue that “has recently come to light.”

Related: Here are the U.S. airlines most likely to take a hit from Raytheon’s jet-engine problem

While the issue does not affect engines currently being produced, a “significant” portion of the PW1100G-JM engine fleet, which powers the Airbus
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+0.12%
A320neo family of narrow-body airliners, will need to be removed and inspected in the next 9 to 12 months, including about 200 accelerated removals due by mid-September. U.S.-listed shares of Airbus
EADSF,
+3.22%
fell 2.5%.

“The business is working to minimize operational impacts and support its customers,” Raytheon said.

On the company’s earnings call, Chief Executive Greg Hayes said the company understands the issue and has begun to address it.

“That said, clearly this will have an impact on Pratt & Whitney and our customers,” he said, according to a FactSet transcript.

Chris Calio, chief operating officer, said the issue is that the powdered metal used to produce certain engine parts may reduce the life of those parts. The metal has been used in Pratt’s products for decades, but the company has determined that the contamination was present in rare instances in metal produced from roughly the fourth quarter of 2015 into the third quarter of 2021.

Beyond the initial 200 engines to be removed, Pratt is expecting that about 1,000 additional PW1100 engines will be removed for enhanced inspection.

Some were already on track to be sent for regular shop visits in 2023 and 2024.

“And so the incremental impact to the fleet is still under evaluation,” Calio said. “Capability to perform the accelerated inspections, which are focused on the high-pressure turbine disks, is already in place, and Pratt is developing plans to optimize shop-visit capacity within its network to complete these inspections as quickly and efficiently as possible.”

The next step will be to publish a service bulletin describing the inspections, and the Federal Aviation Administration will likely follow with an airworthiness directive.

The issue dominated analysts’ questions, which were tougher than is conventional on earnings calls.

“When you look at the litany of issues that have happened here with this engine, everything from hot section issues, manufacturing issues, do you have a cultural issue in your engineering workforce?” asked Bank of America analyst Ronald Epstein.

“Are people not talking to each other? And I mean, it also begs the question, how could you guys possibly not know about this at Paris when you did this major investor event?” he asked, referring to last month’s Paris Air Show.  

Calio said it was a manufacturing-quality issue that was first uncovered in 2020 when there was an incident with a V2500 turbine disk that turned out to be the result of a rare contamination in the metal. The company immediately inspected the entire V2500 fleet and reviewed the powdered-metal process, among other safety measures.

“So I would say, look, we’re on top of it,” Calio said. “We’ve got this. It’s going to be expensive. We’re going to make the airlines whole as a result of the disruption we’re going to cause them and I think, you know, we’re going to work ourselves through it. It’s not an existential threat to RTX. It’s not an existential threat to Pratt. It is a problem and we have them every day and we’ll solve it.”

Raytheon
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acquired Pratt & Whitney as part of its merger-of-equals transaction with the former United Technologies Corp. in 2020. The company recently announced that it will change its name to RTX Corp. on July 28.

“Given that RTX hosted an investor event at the Paris Air Show only last month, we had expected this to be a surprise free set of results,” analyst Robert Stallard from Vertical Research Partners wrote in a note to clients.

“So this fresh issue with the GTF engine, on top of the existing [maintenance, repair and overhaul] issues, is another blow that the stock could do without,” he wrote in an early note.

In a later update, Stallard said the stock move shows “some investors are clearly throwing in the towel on RTX.”

However, that reaction may be overdone, even if it’s understandable, he added.

“New engine families do have reliability issues, whilst the aero supply chain problems are well known—the fact that this latest issue is all internal arguably makes it worse, but at least it has been spotted and should be addressed over the next year or so,” he wrote.

For investors, the uncertainty is not knowing exactly the scale of the cash hit, as management are unable for now to quantify the full impact.

Vertical Research is sticking with its buy rating on Raytheon’s stock for now.

Raytheon had net income of $1.327 billion, or 90 cents a share, for the quarter, up from $1.304 billion, or 88 cents a share, in the year-earlier period. Adjusted per-share earnings came to $1.29, ahead of the $1.18 FactSet consensus.

Sales rose to $18.315 billion from $16.314 billion, also ahead of the $17.683 billion FactSet consensus.

By segment, sales at Collins Aerospace rose 17% to $5.85 billion, while sales at Pratt & Whitney rose 15% to $5.701 billion. Raytheon Intelligence & Space sales rose 2% to $3.655 billion, and Missiles & Defense sales rose 12% to $4 billion.

The company said it now expects full-year cash flow of about $4.3 billion, down from about $4.8 billion. It expects adjusted EPS of $4.95 to $5.05, compared with prior guidance of $4.90 to $5.05.

Sales are expected to range from $73 billion to $74 billion, up from prior guidance of $72 billion to $73 billion.

The stock has fallen 17.9% in the year to date, while the S&P 500
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has gained 18.6%.