MTUAF - MTU Aero Engines Shares In The Pratt & Whitney GTF Engine Drama

2023-12-01 13:38:32 ET

Summary

• MTU Aero Engines AG recognizes $1.03 billion in costs related to the Pratt & Whitney GTF engine issue in Q3.
• Adjusted earnings and revenues show strong performance, with 21% revenue growth and 33-37% growth in EBIT and net income.
• MTU Aero Engines maintains guidance and expects >13% margins, signaling strength despite the impact of the GTF issue.

In a previous report , I analyzed the sales and profit charges that RTX Corporation ( RTX ) recognized in the third quarter, and those sales and profit charges were in line with expectations. RTX is not the only company that is feeling the pain of the Pratt & Whitney GTF issue. Airlines are obviously also feeling the pain of it, but in the supply chain and among risk-sharing partners there also is cost growth. MTU Aero Engines AG (MTUAF) is such a partner. In October, I already had a first look at the financial consequences for MTU Aero Engines and concluded that there likely would be a $900 million to $1.26 billion impact.

In the company’s third-quarter update, we have been given more details on the costs, which I will discuss in this report accompanied by a discussion of the third quarter adjusted results to see how the underlying business excluding the GTF issue is performing. I will also provide an updated price target for MTUAF stock, given that the stock has gained 13% since I maintained my buy rating in October.

MTU Aero Engines Suffers The Pain Of GTF Engine Problems

I am not going to rehash the entire story of the Pratt & Whitney PW1000G metal powder issue, but do want to take a look at the costs that MTU Aero Engine will have as a risk-sharing partner. MTU Aero Engines has recognized $961 million in customer support costs and $69 million in additional MRO-efforts for a total of $1.03 billion which hit the EBIT line and $1.013 hitting the top line with additional MRO efforts of $200 million that will be recognized over time. So, the previous estimate range of $900 million to $1.26 billion accurately captures the recognized charges in the third quarter and even captures the follow-up MRO-efforts.

Strong Adjusted Earnings For MTU Aero Engines

The adjusted earnings are not used because we are blind to the reality of the GTF cost growth during the quarter, but because the adjusted earnings and revenues provide a better overview of undisturbed performance. Adjusted revenues grew 21% while adjusted EBIT and net income grew 33% to 37%. Whereas earnings outpaced revenue growth, free cash flow generating was only 17% higher, but this could also be driven by a backloaded free cash flow profile that we usually see. MRO (Maintenance, Repair & Overhaul) which accounts for two-thirds of the revenue stream saw 18% growth with slight mix pressure bringing the adjusted EBIT margin to 7.2% from 7.4% in 9M 2022. Revenues in the OEM segment were up 26% with 19% growth in the military business and 29% growth in the commercial business.

What I found interesting is that the military business saw significant growth. In many aerospace companies, we see the military business lagging a bit, but at MTU Aero Engines that is not the case. Margins improved to 23.6% from 20% a year ago on strong mix, revenue growth, and relatively low costs for the nine months in 2023.

MTU Aero Engines Confirms Guidance

MTU Aero Engines kept its guidance constant with >€800 million in adjusted EBIT on €6.1 billion to €6.3 billion in revenues, indicating >13% margins. MTU expects revenues to be at the higher end of the guided range, with FCF and EBIT slightly above the minimum values guided. The guidance being maintained to me is a signal of strength that appreciates the business next to the realities of the issues with the Pratt & Whitney PW1000G.

The impact the cost recognition had on 2023 valuation is rather clear, with no upside for MTU Aero Engines. At the same time, I would not want to focus on 2023 as the hit is recognized in 2023, but the actual impact will mostly be felt in the years after with a cash flow hit of hundreds of millions of dollars that MTU Aero Engines will try to recoup from RTX. If successful, that would provide a boost to the company’s valuation and unlock upside. Even when we don’t factor in the recovery of these cash flows, I feel comfortable assigning a buy rating with a $255 price target, representing a 23% upside.

Conclusion: MTU Aero Engines Has Upside Despite The GTF Cost Impact

If you're an investor for current year earnings, MTU Aero Engines is not the name you would want to be invested in, but that would be the case for many aerospace companies. 2023 offers little to no value on an unadjusted basis, as MTU is suffering the consequences of being a risk-sharing partner. However, in the years after, we see that there is significant upside from current levels and that is even when we consider a free cash flow hit of around $500 million from 2023 through 2025.

I wouldn’t say the GTF debacle is in the rearview mirror since the cost has been recognizing, but most of the work and associated cash burn will take place in 2024 and 2025. However, MTU Aero Engines still rides the long-term demand trend, and we are already seeing how it is seeing significant growth in OEM sales as well as MRO. The GTF issues provide a sizeable headwind to earnings, but even with associated pressures present, I do see a significant upside ahead in the years to come. As a result, I maintain my buy rating for MTU Aero Engines stock.

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