Going into earnings season investors expected Raytheon Technologies (NYSE:RTX) to struggle. With its heavy exposure to commercial aerospace, travel shutdowns have hurt demand for that segment of its business. The company actually beat expectations, yet the stock sold off more than 7% anyway.

The quarter went against conventional wisdom. Commercial, though down, held up better than feared, but Raytheon's defense business was unexpectedly sluggish. And management's commentary indicated the worst isn't over for commercial.

Here's what went right, and what went wrong, for Raytheon in the quarter and a look at what investors should expect heading into 2021.

Investors didn't get the quarter they expected

Raytheon earned $0.58 per share in the third quarter on revenue of $15.05 billion, matching the consensus sales estimate and coming in $0.08 per share ahead of analyst expectations. The company was formed earlier this year via a combination of Raytheon and United Technologies (UTX), and today boasts a diverse set of defense and commercial aerospace assets.

The legacy UTX is heavy on commercial, and that business has been hit hard by the COVID-19 pandemic and its impact on airlines. But those UTX businesses actually delivered slightly better-than-expected margins thanks to cost-cutting efforts and higher military engine sales. So far in 2020, the company has cut $2 billion in costs and conserved $4 billion in cash, largely by streamlining its commercial business.

A plane in a hanger getting maintenance work.

Image source: Getty Images.

It was the legacy Raytheon business, which investors had hoped would help cushion the airline weakness, that underwhelmed. Revenue fell by more than 2% in both the company's missile unit and its intelligence and space unit.

On the post-earnings call, management advised caution for the quarters ahead. CFO Toby O'Brien predicted "another challenging quarter for our commercial aerospace segments," but Raytheon hopes to see defense bounce back.

Will cash flow accelerate in 2021?

Raytheon did generate an impressive $1.2 billion in free cash flow in the quarter, but management attributed much of that to timing issues and kept full-year cash guidance at $2 billion. The Pentagon has been trying to pay its bills more quickly through the pandemic to ensure ample liquidity in the supply chain, and that flowed to Raytheon.

More than $1 billion in merger-related expenses will go away in 2021, and Raytheon will get a cash boost from a planned sale of its Forcepoint cybersecurity unit to Francisco Partners. Analysts hope to see upwards of $5.5 billion in free cash flow next year, but the company wouldn't commit to that target.

On the call, O'Brien confirmed that he expects cash to improve from 2020, but held off on providing any guidance. That vagueness, coupled with concerns the Pentagon's forward payments mean cash could come in short of expectations in the fourth quarter, likely contributed heavily to the stock's post-earnings decline.

There's a lot that goes into a free cash flow number, and Raytheon management is likely pondering the size of contributions to pensions through the rest of 2020 and 2021 as well as future restructuring expenses. Investors should be careful not to get too caught up on the target number, but should take some comfort in Raytheon's confidence that cash generation will improve in 2021.

How long will a recovery take?

The real question is when commercial aerospace will recover. While airline traffic has recovered somewhat from lows set early in the pandemic, CEO Greg Hayes said that Raytheon is not optimistic that the all-important aftermarket -- or sales of spare parts to airline operators -- will rebound quickly.

"I don't expect we're going to see an upturn in aftermarket until sometime next year," Hayes said. "Even if we start to see a recovery in the fourth quarter in commercial air traffic, which is still a question mark, I don't think anybody should be focused on 2021 to see a big uptick in the commercial aftermarket."

Part of the issue is Raytheon's customers likely have a good bit of inventory to burn through before they need to restock, including salvaging parts from airplanes that have been taken out of service. And the company's Collins business could underperform during a recovery, as much of its once-lucrative cabin upgrade business will likely be put on hold while airlines try to rebuild their balance sheets.

A long time horizon is needed

Investors were aware of Raytheon Technologies' issues coming into the earnings release, but prior to the announcement they were willing to look past the near-term issues. Raytheon shares had gained 10% since the beginning of August, nearly twice as strong as the S&P 500, on hopes the defense business would make Raytheon a standout compared to commercial aerospace rivals.

Coming out of third-quarter results, the bull case is not dead, but it isn't delivering as quickly as some had hoped.

Raytheon management believes it can hit incremental margins approaching 50% on commercial aftermarket sales once the business normalizes. Hayes is likely correct that the aftermarket business won't accelerate until next year, but once a vaccine is available, if travel demand does push higher, airlines are likely to lean heavily on used jets instead of buying new ones, and part demand could return faster than some fear.

Defense is a wild card in an election year, but Raytheon has a backlog of $70 billion and its sensors and missiles line up well with government priorities.

For investors interested in waiting out a commercial rebound, Raytheon offers a robust 3.2% dividend yield and a defense counterweight most parts suppliers can't match. The earnings report is a reminder a turnaround is going to take time, but for the patient investor, Raytheon Technologies remains among the more attractive commercial aerospace companies.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.