Most of the attention surrounding Raytheon (NYSE:RTN) right now is understandably related to its pending megamerger with the aerospace arm of United Technologies (NYSE:UTX). But Raytheon, in what could be its final earnings report as an independent company, demonstrated the potential in its portfolio and gave investors plenty to get excited about heading into the merger.

Raytheon, unlike the other defense primes, is not focused on building large military platforms like tanks, ships, or planes, but rather specializes in missiles, space, cyber, electronics, and sensors. Raytheon has always been somewhat of a contrarian in the defense sector, and that will only increase when it combines with the commercial aerospace-heavy UTC portfolio and becomes one of the most diverse large companies in the industry.

Here's a look at how Raytheon performed in the final three months of 2019, and what management had to say about the future.

A choppy quarter, with potential

On Jan. 30, Raytheon reported fourth-quarter earnings of $3.16 per share, $0.04 ahead of consensus estimates, on revenue of $7.8 billion, about $200 million below expectations. For the year, the company reported earnings of $11.92 per share on revenue of $29.2 billion, up 17% and 7.8% year over year, respectively.

"Raytheon had a very successful year in 2019, and our global growth strategy is delivering record results for our shareholders," CEO Thomas A. Kennedy said during a post-earnings call with investors. He added, "Bottom line, we have a strong foundation for the future."

Illustration of a missile interceptor launched off a destroyer.

Raytheon's portfolio includes a range of ship-based missile interceptors. Image source: Raytheon.

The quarter contained a lot of noise. Raytheon beat thanks to stronger-than-expected earnings from its integrated defense systems business, which specializes in air and missile defense, radars, and control systems, and its intelligence business, as well as a lower-than-expected tax rate. The company's space, missile, and Forcepoint cyber business all came in below expectations.

Missiles is Raytheon's largest business, but it registered just 1% sales growth for the quarter, and for the year saw its operating margin drop 70 basis points -- that is, 0.70 percentage points -- to 11%. Management blamed the sluggish sales on timing issues, with some purchases not happening as quickly as expected, implying the company should be able to register better growth in early 2020.

Raytheon generated $2.8 billion in operating cash flow for the quarter, more than $200 million better than guidance, primarily due to improved working capital. For the full year the company generated $4.5 billion in operating cash flow, compared to a pension-adjusted $3.4 billion in 2018.

Sector-best growth for 2020?

Where Raytheon stood out among defense stocks was in its outlook for 2020. Raytheon had record bookings of $12.1 billion in the fourth quarter, resulting in a sector-best book-to-bill ratio of 1.54 (over 1 means more orders are coming in than being fulfilled, a sign of strong demand). Full-year 2019 bookings were $36.3 billion, while its backlog stood at a record $48.8 billion at year's end, an increase of 15% in 12 months.

Raytheon guided for 6% to 8% revenue growth in 2020, a couple of percentage points better than what rivals Lockheed Martin and Northrop Grumman expect. And the company should be able to translate that revenue growth into better earnings, since it expects the bulk of growth to come from space and integrated defense, its two highest-margin businesses.

A Patriot missile battery launches in a desert location.

The Patriot system is popular overseas and helps fuel Raytheon's international sales. Image source: Raytheon.

The company registered strong sales in classified areas, achieving $8 billion in classified bookings for the full year, including more than $2 billion apiece in intelligence and space. While it is impossible to say what exactly that work entails, classified projects tend to be higher-margin contracts.

Raytheon also continues to be the defense prime with the most foreign exposure, providing a nice hedge to potential U.S. budget battles or election-year pressures. International sales were $8.6 billion for the year, or nearly 30% of the company's total revenue.

Buy with confidence

I was hesitant to buy into Raytheon after its planned merger with United Technologies was announced, fearful that due to the all-stock nature of the deal Raytheon shares would be tied to the non-aerospace businesses UTC intends to spin off before the transaction is complete. As the closing date nears, I see no reason not to buy in now.

Raytheon and UTC hope to create the new Raytheon Technologies in April, so it's possible this is the last Raytheon standalone earnings report we will get.

If so, the company used the release to make its case as a defense prime well-positioned in areas like missiles, missile defense, and high-tech sensors that are key to the Pentagon's future strategy and should command strong margins throughout the budget cycle. Raytheon also is strong in areas that are in need of immediate attention to address potential flareups in the Middle East.

The new Raytheon Technologies will have the revenue diversity to lean on defense when commercial aerospace issues like Boeing's 737 MAX grounding arise, and to lean on commercial and international sales when the Pentagon budget is under pressure. Raytheon's fourth-quarter results give investors every reason to be excited about the combination.