SAFRY - Safran: A European Aerospace Powerhouse Stock To Buy

2023-05-02 18:28:05 ET

Summary

• Safran's end market excl. Airbus is strong with strong CFM engine cycles and a fully recovered narrow body capacity.
• The company is a European powerhouse in the aerospace supply chain.
• For the long term and with near-term profit growth, Safran stock is almost a no-brainer buy.

In June 2022, I marked Safran (SAFRF) stock a buy, and since then, shares gained 62%, easily outperforming the market fitting in a list of names in the supply chain, OEMs, airports and aircraft lessors that we have uncovered at The Aerospace Forum for riding the air travel recovery wave. In this report, I am revisiting Safran stock to discuss its first quarter results. Keep in mind that the first quarter results only include revenue results but no insight on profits. That is how Safran reports, but it is still incredibly interesting to see how things are going, especially with OEMs not being able to consistently deliver airplanes to customers.

Market Environment Shows the Recovery is Complete… Almost

Looking at the narrow body capacity, it is observed that the market is recovered compared to pre-pandemic levels. It should be kept in mind that 2019 was impacted by the grounding of the Boeing 737 MAX, which was a pressure on the narrow body capacity that year but for assessing the recovery from the pandemic, 2019 is an adequate comp. So, while Q1 2023 signaled recovery in the narrow body capacity, we do see that from geographical perspective that recovery is largely completed but not everywhere to the same extent.

North America is running 10% above 2019 and China is running 5% above pre-pandemic levels where the return to service progression for the Boeing ( BA ) 737 MAX is helping. Our data model shows that the Boeing 737 MAX which uses CFM LEAP 1B turbofans has surpassed 1,000 flights weekly among other improving metrics supporting both the CFM cycle recovery as well as providing an indication that demand for air travel is indeed on the rise. Europe is nearly recovered at 95% while the Asia Pacific excl. China is still only 80% recovered. So, we should be seeing some growth in overall numbers as Asia Pacific also gains traction on the recovery.

Safran Q1 2023 Revenues Show Strong Growth

Safran revenues grew by nearly 30% positively impacted by a €175 million currency headwind. Organic growth stood strong at nearly 25%. Aerospace propulsion revenues were up by 35%, driven by a 53% increase in LEAP engine deliveries which reached 366 in the quarter, but helicopter engine sales and M88 engines for the Dassault Rafaele saw unit delivery growth of 24% and 42%. Increasing demand for CFM56 spare parts added to the growth. Overall, the aerospace propulsion business saw 56% growth in original equipment revenues and 30.5% growth in services.

The equipment & defense unit saw more moderate growth rates at 10%. One would be inclined to say that this is driven by lower-growth nature of defense but that is actually not the full story. We see that A320neo-related equipment deliveries were down strongly reflecting continued supply chain challenges and customer timing requests. This was offset by higher Airbus A350 (EADSF) and Boeing 787-related deliveries with 15% growth in business and regional jets. Encouraging is the Boeing 787 surge in power distribution systems, which indicates that the supply chain is ramping up production in anticipation of the planned rate increase for the program this year. Reflecting the supply chain challenges OE sales for equipment and defense was up 7% while services grew 27%. The nacelle downward pressure seemingly suggests that Airbus supply chain problems are continuing.

For interiors, business class seats were down 6%, but A350 lavatory deliveries were up almost 50%, resulting in 37% OE growth and 56% growth in services. Overall, revenues were up 28% on OEM sales and 31% on services which is strong given the difficulties in the supply chain.

Safran Confirms 2023 Outlook

Safran has reconfirmed its guidance for 2023 and that makes sense with €5.3 billion in revenues and 53% growth in CFM LEAP engine deliveries versus a 50% targeted increase. There is no reason to revise either upward or downward at this moment even more so given that the services are front-loaded in the year as airlines prepare for the peak travel season. Inflation will have a 300 bps headwind on EBIT margin, which will be offset by cost control and escalators. I would expect H1 to be stronger on margins than H2 as CFM LEAP low margin or no margin deliveries ramp up and services being front-loaded.

Conclusion: Safran Remains an Aerospace Stock to Buy

Safran continued to track well on its targets in Q1. CFM56 spare business provided a boost and CFM LEAP engine deliveries are up in line with the projections for the full year. Some decline in, for instance, nacelles and slides seemed to be reflective of supply chain problems at Airbus, forcing the European jet maker to revise downward on orders with Safran. So, obviously, that is not a nice thing since it affects Safran, but the positive is that Safran does not seem to be the bottleneck while that was the case last year. The company is also shielding itself from potential cost pressures on CFM LEAP service contracts by recognizing revenues as earlier than anticipated shop visits occur, but it does not recognize a profit on those to prevent the possibility of having to revise the profits later on.

Overall, things remain challenging, especially Airbus seems to be having some problems that affect Safran, but the underlying plan is intact and over the mid to longer term, when supply chain issues abate globally, there is a big upside for the stock. Since the company did not provide earnings figures for Q1, I am not going to share a valuation calculation on the stock, but I believe that there is 15% upside to $175 per share.

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