RTX - General Electric Stock Wins Big And More Will Come

2023-07-05 13:05:33 ET

Summary

• General Electric and Safran were the big winners of the Paris Air Show.
• GE Aviation is the only engine supplier with meaningful next generation turbofan exposure to wide-body and single-aisle jets.
• As LEAP profits ramp up and GE transforms into an aerospace play, its stock is looking attractive for long-term investors.

General Electric ( GE ) stock had a formidable H1 2023 stock performance gaining 68% fully supporting my buy rating for the stock, and I believe the company is just at the start of significant growth in its results.

Last month, the Paris Air Show, which typically is the stage for the top airplane manufacturers to announce new business, took place. While airplane orders are extremely interesting to keep track of, there also is business to be won for engine suppliers. Engines are the most valuable parts of the aircraft, meaning that with each airplane order, there also is big business to be won for engine manufacturers. In this report, I will be looking which engine manufacturer was the big winner during the air show.

Big Orders Bring Big Business

In total, there were orders and commitments for 2,426 engines. Most of those orders are to the benefit of General Electric and its partner, Safran ( SAFRF ) which produce the CFM LEAP turbofan via a joint venture. Before I discuss things, it is important to explain how I compiled the overview. During air shows, it is very common that an engine supplier is not yet selected. Normally, these engine orders are assigned an NS (Not Selected) label. However, in many cases, we do know a preference for a certain engine platform and I have taken this into account.

Furthermore, it should be noted that the Boeing 737 MAX with CFM engines, the Airbus A330neo with Trent 7000 engines, the Airbus A350 with Trent XWB engines, the Embraer E2 and Airbus A220 with PW1000G engines are a few examples of single-source engines, meaning that there is no choice for customers to select a powerplant.

So, why did General Electric, together with Safran, end up winning 81% of all engine orders? The answer mostly lies in the customer composition and the geographic area of the customer. On the Airbus A320 family program, customers can choose between the geared turbofan of Pratt & Whitney ( RTX ) or the CFM LEAP turbofans. Initially, many airlines have opted for the geared turbofan from Pratt & Whitney to unlock additional savings unlocked by the geared fan architecture, which makes use of a gearbox that allows components to spin closer to their optimum speeds, thereby enabling a higher efficiency of the engine. However, the engine has been coping with some issues and while teething issues are not uncommon with the geared turbofan they have been persistent. In hot air environment, which provide the most challenging operating conditions, the durability of the engine has been problematic, resulting in lower time-on-wing times, and coupled with MRO capacity challenges, airlines had to ground some of their airplanes. This year’s Paris Air Show saw a significant flow of order activity from Indian Airlines, which operate in said hot conditions. Air India had already selected the CFM engines when the orders with Boeing and Airbus were initially announced. The second big order announcement during the show came from IndiGo, which has previously switched from Pratt & Whitney to CFM engines. Pratt & Whitney has no next generation exposure to wide-body engine platforms in the same way that Rolls-Royce has no exposure to single-aisle engine platforms, which quite easily makes the winning case for the General Electric turbofan platforms.

Normally, we see a market share for the CFM platform of around 55% on the Airbus A320neo family airplanes, but with the order composition it was to be expected that CFM would be winning big as Raytheon Technologies works through the challenges on the engine itself and its MRO capacity.

In terms of value, the CFM LEAP also was the big winner, but with a lower percentage of the total $27.3 billion pie. This percentage is lower mainly driven by the higher value for wide-body engines, giving rise to the overall Rolls-Royce share and the value share of the GE programs accounting for 85% of the share compared to 89% on unit basis.

How About Profits For General Electric?

The difficult thing to assess is how things are going to add to the margins. While jet makers are already secretive on pricing of their airplanes, even more so on margins, and recently have started to omit mentions of list prices, engine manufacturers make even less mention of values and profits. Currently, the services as well as the production of the LEAP engines are loss-making, but this should change by mid-decade. Most engine orders are also scheduled for delivery after mid-decade, meaning that there should be profits on the engine production as well as the shop visits, which is an obvious positive for General Electric as it transforms itself into a pure aerospace company. Safran’s aerospace propulsion segment has a 20% margin and GE Aerospace had a 19% margin in Q1 2023. As profitability improves, we should see significant opportunities for margin expansion ahead as LEAP profits improve and CFM56 shop visits remain strong through the end of the decade.

So, in the shorter term, GE will benefit from strength in aftermarket activity on established programs, while engine production and aftermarket activity for the LEAP will become less loss making and thereby lead to better margins, while over the longer term, we should see LEAP margins maturing. And the aim is to have at least the same level of profitability as on the CFM56 program, which in combination with higher production levels for airplanes should result in higher long-term profitability.

Conclusion: General Electric Positions Itself For Long-Term Profits

The Paris Air Show, without doubt, was a big win for General Electric as Pratt & Whitney could not count on orders from hot environment operators. These wins for General Electric should not be solely viewed over the short term, as the value will be rendered over a number of years. In those years, the profit margins will increase on production and services. How smooth that transition will be in terms of margins will depend on how quickly the margins can be ramped up, but the sales that General Electric is making should be viewed as sales with a long-term profitable aftermarket tail boosted by strong demand for air travel, while it also refocuses its business to become a pure aerospace play.

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