There's a lot to like about commercial aerospace and defense company RTX (RTX 0.61%) in 2025. Its commercial aerospace businesses continue to benefit from the ongoing recovery in flight departures, and both Boeing and Airbus are expecting production ramps this year. Meanwhile, on the defense side, the need to replenish equipment donated to the conflict in Ukraine and increased NATO spending is contributing to record backlogs.

Does it all add up to make RTX a potential jewel in your investment portfolio?

RTX's valuation

Based on the Wall Street analyst consensus and the interpolation of the facts, RTX stock looks undervalued. The table shows historical and estimated earnings before interest and taxation (EBIT) and free cash flow (FCF) for RTX. The last row shows a simple calculation for price-to-FCF (a commonly used valuation multiple). Based on a typical assumption of fair value for a mature industrial at around 20 times FCF, RTX looks like a good value.

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

While the forward price-to-FCF multiple of 23.9 times FCF might look expensive, readers should note that the 2025 FCF figure includes an assumption for the $1.1 billion to $1.3 billion that RTX expects to pay in compensation for the potential contamination issue in the geared turbofan (GTF) engine. RTX was forced into a program to remove and inspect GTFs due to the discovery of possible contamination in the powder metal coating used in the engine.

Stripping out the midpoint of the compensation, i.e., $1.2 billion, and adding that to the FCF figure (to estimate ongoing FCF better) gives about $8.35 billion in FCF for 2025, putting RTX at a more attractive 20.5 times FCF. That's a good valuation for a company growing earnings (EBIT) at a high single-digit to double-digit rate -- something mature industrial companies don't do.

In addition, defense companies have traditionally commanded a valuation premium due to the financial surety of their customer base: governments and defense departments. Furthermore, commercial aerospace companies also carry valuation premiums due to the long-term stream of income coming from servicing the after market on aircraft engines and airplane components.

Everything points to RTX being undervalued.

The near- to medium-term outlook is excellent

There's upside potential to the numbers discussed, and RTX's trading momentum is superb. The company ended 2024 with an overall backlog of $218 billion (compared to $80.8 billion in adjusted sales), including a record backlog of $93 billion in its defense backlog. In fact, the defense book-to-bill ratio for the full year was 1.48, indicating a vigorous growth outlook.

Image source: Getty Images.

There is also upside potential in the commercial aerospace original equipment side, with Airbus and Boeing looking to ramp up airplane production aggressively in 2025 and beyond. On the after-market side, an ongoing recovery in flight departures supports product demand, and management expects 10% growth in the commercial after market in 2025.

Notes of caution

That said, it's impossible to look at companies with heavy defense exposure and divorce them from considering the geopolitical outlook and that of military spending. While increased international spending from NATO is a plus, U.S. Defense Secretary Pete Hegseth is reportedly looking to cut 8% a year from the defense budget.

Moreover, it's not just a question of absolute dollars; there's already a trend whereby the U.S. government is getting tougher in contract negotiations with defense contractors like dividend play Lockheed Martin, Boeing, and RTX itself, notably on fixed-price development programs that have hurt profit margins at all three companies in recent years.

It strikes me that the effort to pressure NATO allies to spend more on their defense needs and meet their obligations is a complementary strategy to offset a potential reduction in U.S. spending. If correct, then the current boom in overall orders could prove short-lived.

Image source: Getty Images.

A stock to buy?

The near-to-medium term sales growth outlook is robust, and RTX's valuation is attractive. However, the optimism should be capped by the uncertainty over the future order book, and orders drive long-term growth. As such, RTX is an attractive stock with good return potential, but it's hard to argue that it will significantly outperform.