Last summer when United Technologies agreed to merge its aerospace business with Raytheon, the two management teams talked up the "balance" that would be achieved by combining UTX's commercial aerospace-heavy portfolio with Raytheon's defense-focused business. The goal, they said, was to create a company that could ride out the inevitable down cycles common to both the commercial aerospace and defense businesses.

Little did they know how soon that thesis would be put to the test. The two companies closed their deal on April 3, forming Raytheon Technologies (NYSE:RTX) just as the COVID-19 pandemic was causing the commercial aerospace sector to collapse. United Technologies shares had lost nearly half their value year-to-date prior to the deal closing, and absent the deal, the fall could have been much steeper.

Here's a look at the challenges that face Raytheon Technologies, and what investors should expect from the newly formed aerospace giant in the quarters to come.

COVID-19 will crimp commercial aerospace revenues

United Technologies can trace its history back to William Boeing and the early days of aviation, and its portfolio still includes some of the biggest names in aerospace, such as Pratt & Whitney (engines) and Rockwell Collins (avionics and aircraft interiors). The business serves both the defense and commercial sectors, but counts on commercial aerospace for the bulk of its revenue.

The COVID-19 pandemic has caused air travel demand to collapse, and airlines that just months ago were looking to expand are now in survival mode. That has meant cutting flights, grounding aircraft, and deferring orders for new planes. With air traffic not expected to fully recover to pre-pandemic levels for three years or more, demand for new planes, engines, and spare parts is likely to be low for the foreseeable future.

Two Pratt & Whitney employees work on an aircraft engine.

Image source: Raytheon Technologies.

Pratt & Whitney and Collins Aerospace are among the affected. Raytheon on April 14 announced 10% pay cuts for salaried employees in the corporate offices and workers in the commercial-focused businesses. The businesses are also implementing furlough programs for hourly employees, which will continue as needed.

In the memo to workers announcing the cuts, CEO Greg Hayes (formerly head of United Technologies) said they are "temporary measures that we must take to responsibly manage the company through the business repercussions of the COVID-19 pandemic."

Overall, the company intends to cut about $2 billion in costs and take other actions to conserve about $4 billion in cash on the commercial aerospace side.

Defense to the rescue

In a rough environment like commercial aerospace is facing, it's nice to have a $70 billion backlog of defense orders to fall back on. Much of that is thanks to Raytheon, which is a leading provider of missiles, sensors, and electronics for the Pentagon.

Sales from the legacy Raytheon side of the business jumped 6% in the first quarter, driven by a 15% jump in its space and airborne systems unit and an 11% gain in its missile defense and advanced electronics unit. The business also ended the quarter with a strong 1.46 book-to-bill ratio -- that metric measures of the volume of new orders coming in compared to what went out the door. Missile systems was the big driver of that, with a book-to-bill ratio over 2.0.

Missiles also gave the combined company its first big defense win, with Raytheon Tech on April 17 beating out Lockheed Martin for the contract to develop the Air Force's new Long-Range Standoff Weapon. That's a cruise missile program worth upwards of $10 billion in the years to come.

Illustration of a a Raytheon missile launching from a destroyer.

Image source: Raytheon Technologies.

Raytheon Technologies has suspended most guidance for 2020 due to COVID-19 and its impact on airlines, but the company still expects to generate positive free cash flow for the year thanks to its defense business.

The legacy United Technologies business contributed about $24 billion of the combination's $26 billion in total debt at the time of the merger. With commercial aerospace cash flow expected to be breakeven at best, it seems unlikely the company's robust 4% dividend yield would be safe absent the merger.

Raytheon Technologies has said it remains committed to the dividend, with Hayes telling investors on May 7 the company has "sufficient cash and liquidity to maintain a competitive dividend even in this very difficult environment." For that, investors have defense to thank.

A survivor, but not yet a buy

In the April 14 memo to employees, Hayes continued to talk up the balance of the unified portfolio, saying the "robust strength" of the defense business "will help shield the company overall." For legacy United Technologies shareholders, including many who were against the deal when it was announced, that shield must feel pretty reassuring.

For legacy Raytheon holders, the focus on the value of diversification is likely bittersweet. But it is worth noting that shares of Raytheon Technologies have held up well in their first month of trading, nudging out defense heavyweights Lockheed Martin and Northrop Grumman. And defense investors only need to go back a few years to recall a time of Washington budget battles and sequestration, when Pentagon contractors badly underperformed commercial aerospace companies.

I'm of two minds about Raytheon Technologies shares, which is perhaps understandable when it comes to a company operating in two sectors with divergent cycles. For an investor seeking exposure to commercial aerospace, RTX is a solid option now thanks to the strong defense business. But for those seeking investments among defense companies, there are better options that don't have a commercial aerospace albatross weighing them down.

I'm a big believer in the power and potential of the Raytheon Technologies portfolio, and the dividend will make it easier for shareholders to ride out this storm. But for now, I see better opportunities elsewhere for my investing dollars.