General Electric, Raytheon Technologies, and the $7 Billion Race

Aviation-focused industrial titans General Electric (GE 4.72%) and Raytheon Technologies (RTX 3.36%) look like excellent options for investors. Both are set to substantially increase earnings and free cash flow (FCF) in the coming years. Instead of thinking about them as suffering companies in the beaten-down aerospace industry, there's a case for arguing that they are both embarking on a multi-year growth trajectory that will lead them to substantive FCF generation. The question is: Which will get to $7 billion in FCF first?

CEOs set out their stall

The CEOs of both companies have publicly declared that they will get FCF to at least $7 billion in due course. On GE's recent first-quarter earnings call, CEO Larry Culp reiterated the company's target of a high-single-digit FCF margin by 2023, arguing that if GE got back to revenue of $85 billion to $90 billion in 2023, a high-single-digit margin would get "us to a $7 billion free cash number."

Image source: Getty Images.

It's a somewhat similar story with Raytheon. On the company's fourth-quarter earnings call in January, CEO Greg Hayes said that, excluding investments made as a result of the 2020 merger, FCF in 2021 would be "north of $5 billion" and "that's going to continue to grow over the next several years back to that $8 billion to $9 billion" management had forecast before the COVID-19 pandemic began.

I'll get into more detail on guidance below, but first here's a look at the Wall Street consensus on FCF and what it means for the companies' price-to-FCF multiples. As a rough guide, a multiple of 20 times FCF or less is generally seen as a good value for a mature industrial company. Wall Street has Raytheon getting to $7 billion in FCF first and both stocks look like a very good value in 2023.

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

General Electric

As you can see above, the Wall Street consensus is not quite as aggressive as Culp's target. Analysts have GE reaching $6.3 billion in FCF in 2023. However, Culp's FCF pronouncement does jibe with the company's implied earnings guidance from the investor day presentation in March.

As a reminder, management told investors to expect net debt of $33 billion to $37 billion by 2023, and net debt to earnings before interest, taxation, depreciation, and amortization (EBITDA) of 2.5 times EBITDA or less. These figures imply EBITDA in the range of $13.2 billion to $14.8 billion in 2023, while the Wall Street consensus is for $12.7 billion. Either GE's internal projections are too aggressive, or analysts are being too conservative.

To get there, GE is aiming to increase profit margins at its power and renewable energy segments to those of its peers, while relying on healthcare to keep generating steady cash flows and aviation to embark on a multi-year recovery as commercial air traffic returns.

Raytheon Technologies

The two workhorses of the global aviation industry are the Airbus A320 family and the Boeing 737 family of aircraft. If you are flying on the newest variants you are either flying an engine made by GE joint venture CFM International (the sole option on the 737 MAX, and an option on the A320 NEO), or Raytheon's Pratt & Whitney geared turbofan (an option on the A320 NEO) engine.

That means if commercial aviation is coming back, so will Pratt & Whitney. Moreover, Raytheon's Collins Aerospace is the world's most comprehensive aviation equipment manufacturer, making everything from avionics to cabins and aerostructures. 

Image source: Getty Images.

While the commercial aviation-focused businesses makes a gradual recovery, Raytheon can rely on the FCF generation from its defense focused businesses, Raytheon Intelligence & Space and Raytheon Missiles & Defense. It's a compelling proposition, and under Hayes, Raytheon has acquired a reputation for wringing every possible dollar of cost synergy out of its mergers.

Who will get to $7 billion in free cash flow first?

Wall Street has Raytheon hitting the target first, but GE's management probably believes it's got a shot at getting there ahead of its rival. Probably, the key to the debate is the pace of the recovery in commercial air traffic. While recovery is critical to both companies, GE has more self-help potential through improving its FCF generation at power and renewable energy, while investing for growth in healthcare.

On a balance of probabilities, I think GE is only a slightly worse bet than its rival. And in terms of investment opportunities, both stocks look very attractive. If they can trade on less than 20 times FCF in 2023 and have a long growth trajectory from the companies' mix of businesses, then both stocks are worth buying.