The case for buying Raytheon Technologies (RTX 0.54%) is relatively simple. In the coming years, the defense businesses will provide earnings and cash flow support as the commercial aviation businesses embark on a multi-year recovery. If this transpires in line with market expectations, then the stock looks like a very good value. It's a powerful case, and here are the charts to demonstrate it.

Downside protection from defense revenue

The first point is that Raytheon is a company with substantive defense and space revenue. Indeed, in October 2020 CEO Greg Hayes noted that two-thirds of Raytheon's revenue was coming from defense-related activity -- hardly surprising given the collapse in commercial air travel. 

Airplane taking off.

Image source: Getty Images.

Of course, that percentage will shift as the commercial aerospace market recovers. Nevertheless, it's a timely reminder that Raytheon's defense business is likely to provide support in difficult times. That's a big thing in the aerospace industry because it takes multi-year investments to produce aircraft engines and other high-ticket items.

Raytheon Technologies revenue share.

Data source: Raytheon Technologies presentation.

Raytheon Technologies free cash flow will improve

Digging into the details, it's difficult to precisely attribute defense revenues across the segments because the former Raytheon Company businesses, although heavily defense focused, also contain some commercial aerospace businesses. Similarly, the former United Technologies commercially focused businesses, namely Collins Aerospace and Pratt & Whitney, also contain some defense businesses.

To simplify matters let's assume that Raytheon Intelligence and Space (RIS) and Raytheon Missiles and Defense (RMD) represent the defense-focused businesses and the other two segments represent the commercial business. Fortunately, the defense businesses are performing pretty much as expected through the pandemic, so you can go back to the free cash flow (FCF) forecasts for RIS and RMD that were made at the time of the merger. 

Missiles being launched.

Image source: Getty Images.

The former Raytheon Company businesses (RIS and RMD) were forecast to generate around $4.1 billion in unlevered FCF (unlevered means it excludes interest payments) from 2020 to 2023. With that underlying support in place, Wall Street analysts are expecting Raytheon Technologies' free cash flow (FCF) to increase substantially as Raytheon's commercial aerospace business improves.

The chart below shows the Wall Street analyst consensus for FCF and the price to FCF ratios based on the current market cap.

Raytheon Technologies free cash flow valuations.

Data source: marketscreener.com, author's analysis.

A good relative valuation

To put these valuations into context, Raytheon could trade on 18.5 times its FCF in 2022. That's a very favorable valuation considering that most observers, including Raytheon's CEO Greg Hayes, are not expecting a return to 2019 levels of air traffic until 2023. In other words, Collins Aerospace and Pratt & Whitney should continue to grow strongly at least until 2023 when air traffic, hopefully, makes a complete recovery to 2019 levels.

The point about the potential growth opportunity for the commercial businesses is well illustrated by management's adjusted operating profit guidance for 2021. Raytheon's management outlined its estimates for growth from the second to fourth quarters in 2021 compared to the same period in 2020. The idea is that investors can compare growth from the period after the COVID-19 pandemic spread globally.

Based on management's guidance, Collins Aerospace and Pratt & Whitney are set to grow strongly. Granted, much of this is because of very easy comparisons and the rate of growth will slow in the future, but investors can still look forward to a multi-year expansion in the two commercial aerospace businesses.

Raytheon Technologies forecasts.

Data source: Raytheon Technologies presentations. Data in millions of U.S. dollars.

Moreover, it's important to remember that commercial aerospace businesses are very attractive in their own right. For example, Collins Aerospace's aftermarket revenue has an opportunity to grow for many years to come, while Pratt & Whitney's geared turbofan engine on the Airbus A320 NEO has many years of aftermarket revenue to come as the engines are flown more.

An air passenger.

Image source: Getty Images.

A stock to buy

On the company's recent earnings call Hayes said that FCF is "going to continue to grow over the next several years back to that $8 billion to $9 billion that we had forecast" at the time of the merger. If he's right, then it could be a great time to get long-term exposure to the stock. 

All told, if you believe there will be a successful vaccine rollout and travel restrictions will be gradually lifted, then Raytheon is an interesting option to buy. It's going to take time for a full recovery to take place, but when it does the company will be very well placed to take advantage.