The aerospace sector is a key battleground for investors going into 2021. On the one hand, stocks in the sector look attractively priced. On the other hand no one really knows how the recovery in commercial aviation will take shape next year. Let's shed some light on these issues by comparing the investment cases for two of the leading companies in the sector, namely Boeing (NYSE:BA) and Honeywell (NASDAQ:HON).

Honeywell International

The industrial conglomerate is a well-run company with its fingers in many industrial pies. The chart below shows a breakout of its segment profit in 2019. Obviously, investors will be concerned by the exposure to aerospace, but there's reason to believe that Honeywell is relatively well-positioned in the industry.

Planes in the air.

Image source: Getty Images.

For example, defense and space revenue contributed 38% of aerospace revenue for Honeywell in 2019 and, due to the slump in commercial air travel, it was responsible for 56% of the segment's sales in the third quarter. Furthermore, Honeywell's aerospace segment has relatively high exposure to business and general aviation (typically around a third of revenue) -- a market set to return to 2019 levels by the summer of 2021.

Due to its defense and business aviation exposure, Honeywell is well-positioned to deal with any downside to commercial aviation in 2021.

Honeywell segment profit.

Data source: Honeywell presentations. Chart by author.

Honeywell's other segments have mixed growth prospects. The strongest is SPS, with warehouse automation growing strongly as a result of demand from e-commerce warehousing. The company's barcode scanning and mobility products contributed to growth in the third quarter. 

HBT has a growth opportunity coming from increased awareness among building owners for the need to create healthier building environments. In addition, HBT clients can benefit from new digital technologies that allow them to gather real-time data on building performance. The PMT segment's exposure to oil prices through process automation and refining catalysts and absorbents means it's likely to recover slowly.

All told, Honeywell's mix of businesses means it has growth potential in the next few years. However, the issue with Honeywell is not the quality of the business; it's the price of the business. Industrial conglomerates are often seen as "fair value" when trading at 20 times free cash flow (FCF). Given that Wall Street analysts are forecasting $5.4 billion in FCF for 2021 and $5.9 billion in 2022, Honeywell's market cap of $150.3 billion means it trades on 28 times and 25 times its FCF for 2021 and 2022. That looks historically expensive.

HON Price to Free Cash Flow Chart

Data by YCharts

Boeing

The aerospace giant has been hit hard in recent years, but that was then and this is now. If the commercial aviation market recovers well, then you can make a strong case for buying the stock. After all, this is a company that generated $13.7 billion in FCF in 2018 -- equivalent to around 10.6% of its current market cap. The implication is that even if getting back to FCF numbers like that takes five years, and it surely will take at least that, Boeing is a good value right now.

That said, a lot of things will need to go right. Boeing will have to regain market share in the narrow-body market after the 737 MAX grounding. Meanwhile, the wide-body market -- where Boeing is usually seen as stronger than Airbus -- will take longer to recover. As such, the idea that the new 777X will act as a spur to a wide-body replacement cycle beginning in this decade is now in question.

Rear view of passengers sitting on a plane

Image source: Getty Images.

In addition, Boeing's market assumptions look overly optimistic, and management recently walked back expectations for positive FCF in 2021. Throw in the likelihood of near-term weakness due to a resurgence of COVID-19 cases in Europe, and Boeing still faces plenty of challenges.

Which stock to buy?

You can think of the debate as being one between buying an "all-in" play on aerospace and defense (Boeing) compared to buying a company with upside exposure to a recovery in aerospace but with a collection of industrial businesses attached.

In this context, here is a summation of the key points:

Risk/Reward

Honeywell International

Boeing

Risk

Downside limited by business and general aviation exposure, and growth businesses within the portfolio.

Significant downside if continued loss of market share in narrow-body and wide-body market fails to recover. Guidance looks optimistic.

Reward

Limited upside due to valuation

Significant upside, but only if commercial aviation recovers, and a lot of things need to go right for Boeing

Data source: Author's analysis.

The short answer is neither. Honeywell is a great company, but it's not a buy at this price. Meanwhile, Boeing has operational as well as end-market challenges, and there are better ways to play an aerospace recovery. 

However, if choosing between the two stocks I think Boeing is the better buy. If the coronavirus vaccine accelerates the natural process of herd immunity and commercial aviation improves notably in 2021, investors will begin to build in more positive scenarios for Boeing. That could provide significant upside to the price, while Honeywell has little upside potential at this price. Obviously, risk-averse investors will avoid Boeing, but on a risk/reward basis it's the better priced of the two stocks right now. 

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.