RLLCF - General Electric: Aviation Is An Undiscovered Gem

• GE's total debt was $35,140 million in Q2 2022, down 47.2% year-on-year.
• GE's aviation division generated $6,127 million in Q2 2022 revenue, up 26.7% from Q2 2021.
• GE Aerospace is a leader in the development of electric and sustainable aviation fuel engines for commercial aviation.
• GE Aerospace's profit margin was 18.7% in the second quarter of 2022, which almost reached the pre-COVID value.

In this article, the prospects for the development of the aviation business of General Electric ( GE ), which is the most promising asset among other divisions of the company, will be analyzed. GE Aerospace is the world's leading manufacturer of jet engines for commercial and military aviation and is the primary powertrain used in Boeing ( BA ) and Airbus ( EADSF ) ( EADSY ) aircraft and helicopters. Thanks to the technological advantages of GE Aerospace engines relative to Pratt & Whitney and Rolls-Royce ( RYCEF ) ( RYCEY ), the company continues to win many tenders, leading to an increase in share in the aviation industry. With the recovery of commercial air traffic from the effects of the COVID-19 pandemic, the company has huge potential for business development in the coming years.

GE Aerospace's Financial Position

GE Aerospace's commercial aviation division generated revenue of $4,306 million in Q2 2022, up 38.2% year-over-year. While revenue from sales of military engines and related services was $1,096 million in Q1 2022, showing a more modest increase relative to the previous quarter.

The significant increase in GE Aerospace's revenue was due to many factors, one of which is the increase in production and maintenance of passenger aircraft, and the restoration of passenger traffic in many countries. According to the Transportation Security Administration , the total number of passengers was 56.55 million in July 2022, which significantly exceeded the values in the previous two years and almost approached pre-COVID levels.

In my analysis, US airport traffic tracking is one of the criteria that predict GE Aerospace's future revenue to be within 12% of the actual value shown in quarterly reports. The main reason for this dependency is that commercial aviation accounts for about 70% of GE Aerospace's total revenue. And as a result, the 33.4% increase in US air passenger traffic in the 2nd quarter of 2022 year-on-year led to a 26.6% increase in revenue for GE's aviation division over the same period.

Despite a significant improvement in GE Aerospace's financial position, new outbreaks of COVID-19 in some regions of the world and the introduction of restrictive measures in China in the first half of 2022 led to an increase in the remaining performance obligations (RPO), which amounted to about $130.14 billion at the end Q2 2022, up 2.1% QoQ. I believe inflationary pressures in the supply chain and logistical problems in the supply of materials for engine production will decrease in the coming quarters, which will lead to the ability of the company's management to convert RPO into revenue.

GE Aerospace has the highest profit margin in the company's structure, which was 18.7% in Q2 2022, a significant increase from the previous year.

It should be noted that the profit of the company's aviation division amounted to $1,148 million in the 2nd quarter of 2022, an increase of 26.4% QoQ, mainly due to an increase in the volume of supplies of spare parts and prices for goods, services under long-term contracts. As a result, GE Aerospace is a key contributor to the company's cash flow growth, a significant share of which goes to repay the company's total debt, which decreased by 47.2% in Q2 2022 compared to Q2 2021.

As a result of an efficient business model and a leading position in the aviation industry, I expect GE Aerospace's margin to continue to improve in the coming years, which will positively impact the decline in the Total Debt/EBITDA ratio. In my estimation, GE will have no problem repaying loans and senior notes totaling $8 billion over the next two years, bringing the Total Debt/EBITDA ratio down to 3.2x. As a result, this will help improve the credit rating and increase interest in the company from institutional investors.

GE Aerospace in Commercial Aviation

The commercial aviation division has many opportunities to improve the financial position of the business in the coming quarters, mainly by resolving engine manufacturing issues. For example, total commercial engine sales were 355 units in Q2 2022, down 28 units from the previous year, mainly due to supply chain disruptions due to COVID-19 outbreaks in Q2 2022 in Asia and a slowdown in production of the GEnx engines used in the Boeing 787 and 747-8 aircraft. However, this decline was partly offset by increased sales of LEAP engines, which are manufactured by CFM International, a business formed by GE Aviation and Safran Aircraft Engines.

In my estimation, engine sales will recover to pre-pandemic levels by 2023, thanks to increased production of Boeing and Airbus commercial aircraft, even despite the military conflict in Eastern Europe. One of Boeing's most popular aircraft, the 737 MAX powered by CFM International's LEAP-1B engines, has resumed flights in 2020 after resolving technical issues that led to two plane crashes in 2018-2019. Due to the technological advantages of the 737 MAX , including higher fuel efficiency compared to the A320neo and less need for maintenance, airlines are gaining interest in this aircraft. However, the 737 MAX has yet to return to commercial service with Chinese airlines due to additional pilot training and aircraft modifications required by the Civil Aviation Authority of China (CAAC) in order to obtain final approval to fly. I believe that the resumption of flights on these aircraft will occur in the Q4 2022-Q1 2023, which will give a huge boost to the aviation industry. In total, 51 Boeing aircraft were delivered in Q2 2022, up 16 units QoQ and showing similar dynamics for Airbus , which is positive for GE, as prerequisites are set for growth in orders for the company's engines and the volume of their service already in the nearest future.

This year's Farnborough Air Show, one of the largest in the world and one of the most important for the industry, received many orders from major commercial aircraft manufacturers. However, Boeing eclipsed its competitors with orders for 176 aircraft, 91 more than Airbus. A major contributor to the success was Delta Air Lines (DAL), which ordered one hundred 737 MAX 10s with an option to purchase thirty more. And in general, the situation with orders is as follows.

It should be taken into account that significant interest in Boeing and Airbus creates long-term orders for CFM International's LEAP and General Electric's GEnx engines, which are equipped with aircraft of these companies.

Before moving on to discussing GE Aerospace's equally important military aviation division, it should be noted that the company has successfully completed testing of the Passport commercial engine, which runs on 100% sustainable aviation fuel ('SAF'), helping to increase the lead over its closest competitors. In addition, the company does not stop at the progress made and is the first in the world to test electric engines and plans to put them into operation no later than 2035 . I believe that the direction of the company is fully consistent with the desire of governments to reduce CO2 emissions, and with President Biden's $370 billion bill aimed at combating climate change and reducing US emissions by 40% by 2030, this opens up an opportunity for GE. According to Air Transport Action Group forecasts , SAF consumption is expected to be a significant share of the aviation industry's energy consumption by 2050, opening a window of opportunity for GE Aerospace.

As a result, I expect GE Aerospace to continue to increase its commercial engine market share.

GE Aerospace in Military Aviation

Even though military revenues grew, mainly due to the growth of services, on the other hand, there was a decrease in the supply of engines from 155 units in Q2 2021 to 131 units in Q2 2022. This was mainly due to logistical difficulties in the delivery of components and delays in the supply of T-700 used in various helicopters, including the Boeing AH-64 Apache.

However, I believe military engine demand will recover quickly in 2H 2022 due to the improvement in the COVID-19 situation, and continued high interest from the US Department of Defense and other governments. Moreover, Russia's ongoing war against Ukraine and the tense situation regarding Taiwan create an urgent need for technological improvements in NATO weapons. For example, the company reported that the XA100 adaptive cycle engine for Lockheed's F-35 ( LMT ) has achieved the performance expected by the US Air Force. This engine has many advantages over those already in use, namely the XA100 provides 30% more range for the F-35A, can accelerate 20-40% faster and has more power while using less fuel. With the Pentagon and Lockheed agreeing in July 2022 to build 375 F-35s , this opens up a huge commercial opportunity for the company ahead of the GE split.

GE Aerospace Spin-Off Plan

After completing all planned spin-offs in 2023-2024, GE Aerospace will become an aviation-focused company from 2024, unlocking its potential that has been hidden by GE's unprofitable renewable energy division and the slow-growing GE Power business.

Currently, there is no Form S-1 that would disclose information about the financial position of GE Aerospace, necessary for a more accurate assessment of the value of this division of GE. However, based on current information and taking into account the financial indicators of the aerospace industry, I estimate the value of GE Aerospace at $65-70 billion.

Conclusion

GE Aerospace is the world's leading manufacturer of engines for commercial and military aviation and is the primary powertrain used in Boeing and Airbus aircraft and helicopters. Under the management of John Slattery, the company has effectively managed the impact of COVID-19 and continues to develop new generation engines, thereby increasing interest from airlines. In my estimation, GE Aerospace and GE Healthcare, whose business was discussed in the previous article , are the key companies in the GE structure that are significantly undervalued by Wall Street. Given the company's CEO's demonstrated ability to handle complex business challenges, reduce debt, and increase revenue and business margins, I am confident in the company's bright future and will sell GE stock at $125 per share.

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