The airplane manufacturer or the aerospace supplier? It's not been an easy year for either stock, but the advent of a coronavirus vaccine will herald an improvement in commercial aerospace, and that should benefit Boeing (BA 0.19%) and Raytheon Technologies (RTX -1.46%). But which stock is a better buy for investors? Let's try to shed some light on this question.
Three factors to consider
Unfortunately, it's extremely difficult to accurately predict the shape of the recovery in the commercial aerospace market, so investors need to consider a range of outcomes. As such, three factors should be considered:
- The downside risk if there is a weak recovery. Which stock will be more heavily hit and therefore is more exposed?
- The upside risk of a strong recovery. Which stock will outperform if commercial aerospace performs better than current market expectations?
- What expectations have both sets of management baked into their guidance?
The downside risk
There's little doubt that Raytheon Technologies has less downside risk than Boeing right now. There are two main reasons for this. First, Raytheon has a much higher share of its revenue coming from defense and space right now than Boeing does. In fact, Raytheon is currently generating two-thirds of its revenue from its defense businesses, whereas Boeing's defense space and security segment was responsible for 45% of its revenue in the first nine months of 2020.
The difference is stark when looking at each company's free cash flow (FCF) outlook. For example, Wall Street analysts are expecting around $4 billion in FCF from Raytheon's defense businesses to support FCF generation of around $4.5 billion in 2021. Contrast this with expectations for an $800 million cash outflow for Boeing in 2021.
Indeed, Boeing CFO Greg Smith walked back expectations for positive FCF in 2021 during the recent earnings call: "While we're still aiming to turn cash positive in late '21, the recovery and the continued elevated virus cases make the path much more challenging. Based on what we know today, it's looking more likely that we will be cash flow-positive in the 2022 time frame," he said.
The upside risk
On balance, Boeing probably has more upside potential in light of a strong recovery in commercial aerospace, but not by that much. The reason being that Boeing is unfavorably positioned for the kind of recovery that's likely to take place. First of all, the 737 MAX debacle has damaged the company's reputation, and it's unclear if passengers will object to flying on the plane given the negative publicity the company has endured. As such, Airbus is crushing Boeing on orders and deliveries in 2020.
In addition, the likelihood that domestic flights will lead the recovery and international flights will lag is not good news for wide-body orders -- an area where Boeing tends to outperform Airbus. Moreover, Boeing's management had high hopes for a wide-body replacement cycle to begin in 2020, leading to a pickup in sales of its 787 and new 777X airplanes. That's not going to happen now.
In contrast, Raytheon's most important single product is the (Pratt & Whitney) geared turbofan engine on the Airbus A320 NEO, and given the 737 MAX difficulties, that's a relatively safe place to be right now. Simply put, Boeing needs more things to go right than Raytheon does right now.
That said, if the commercial aerospace market does pick up very strongly, then Boeing has a lot of upside potential, not least because its profit margins tend to be a function of deliveries.
In this regard, Raytheon wins out. CEO Greg Hayes usually gives cautious and considered guidance. For example, on the recent earnings call, he told investors, "I don't think anybody should be focused on 2021 to see a big uptick in the commercial aftermarket," while maintaining expectations for a return to 2019 levels of passenger traffic to 2023.
In comparison, Boeing's latest commercial outlook appears optimistic. For example, Boeing's outlook for commercial air traffic implies a high-single-digit growth rate in passenger traffic from 2025 onward. Similarly, its 10-year forecast for services demand is just 4% lower than last year's forecast -- made before the pandemic spread out of China.
Boeing or Raytheon?
On balance, it has to be Raytheon. While Boeing's greater upside potential will attract aerospace bulls, the downside risk should always be considered too. In addition, Boeing needs more things to go right vis a vis competition with Airbus. And finally, Raytheon's guidance appears to be setting the company up to over-deliver, while Boeing's market assumptions are subject to questioning. All told, Raytheon Technologies is the better buy.