RTX - Safran: Growing Rapidly Likely To Grow Even Faster In 2023 - Undervalued

Summary

• Safran SA in the first three quarters of 2022 achieved organic growth of 17.9%.
• Safran is a 50% owner with GE aerospace of CFM, a joint venture which manufactures engines used by Boeing, Airbus, and the Chinese airline manufacturer of the new 919.
• CFM's narrow-bodied engine the CFM 56, and the newer Leap, which is planned to double production in 2023, create a surging growth in a highly profitable service increasing profitably by 40%.
• Safran is a strong buy.

Safran SA

Safran SA ( SAFRF , SAFRY ) is a French aerospace company that is 17% owned by the French government. The largest private owner is Blackstone (BX). The business employs 76,000 people worldwide, and it has 18,000 employees in the U.S. They have a large variety of businesses organized into three groups.

The table below compares the third quarter of 2022 to the same quarter in the previous year. Aerospace propulsion produced revenue of 2,503 million euros in the third quarter. That is a growth rate of 38% over the same quarter in 2021. However, the currency changes are substantial, and so, just looking at the physical growth or organic growth, the volume has increased by 25.9%. The group profit margin for the first half of the year was 14%.

Safran Third Quarter

EUROS Millions

Table by Author

The Equipment and Defense segment makes landing gear, including for the Boeing (BA) 787 and the Airbus ( EADSF , EADSY ) A350, space launch systems, engine nacelles, and weapons systems. Its growth and margins are strong but not spectacular.

The aircraft Interiors and seating are new additions to the company. The group business' objective is to achieve breakeven by year-end.

CFM and the Leap Engine

CFM, a joint venture with General Electric (GE), was founded to produce the CFM56 engine for the Boeing 737 and later for the Airbus A320. This engine was superseded by the Leap, but most of the narrow-bodied profits come from spare parts and service from the CFM56. The Leap engine was brought out to compete with Pratt & Whitney's geared turbofan. The geared turbofan was a $10 billion effort to regain position in the narrow-bodied jet market. Jet engines are sold at a loss to gain high profits from selling service parts. In the case of the Leap, CFM took an additional 30% off the price. Pratt & Whitney followed. Frantic cost reduction efforts took place on both competing engines. The Leap cost was cut by 44%. However, it is still losing money, so CFM launched an effort to take an additional 15% off the manufacturing costs to bring the engine to breakeven by the beginning of 2025.

In 2019, CFM produced more than 2000 narrow-bodied engines. The Leap engine accounted for more than 1700 units in 2019. In the first three quarters, only 812 Leap engines were shipped in 2022. The Leap production by quarter is summarized in the table below:

Leap production in Q4 could be close to 500 units, the average planned for 2023. Neither Boeing nor Airbus has enough engines. CFM has said that they have supply chain issues that caused them to continually miss their airline delivery plans.

In order to cut 15% of the manufacturing costs, the engines have been changed substantially. Parts are made by additive manufacturing, which is a 3D printing process for metal parts. They use new polymer composites and new medals, including ultra-hard steel. Ceramic parts are also used. CFM refers to the delay as a supply chain problem, but the redesign is the major reason for the delay. The plan was to switch lower-cost parts into the production line without delays. This did not work. The cost of the current production is lower than before the cost reduction began, but it is not at break even. The production objective for 2023 is 2000 Leap units. This will still leave the airframe manufacturers short of engines in 2023, but they can produce far more aircraft.

Market Penetration

The Leap engine has been a big success in the market. Boeing uses the Leap exclusively, because the 737 is close to the ground so the Pratt & Whitney engine is too big. About 60% of the 320 Aircraft use the Leap. Pratt & Whitney has the balance.

Half of CFM revenue and profits have reported a part of Safran's aerospace propulsion group. Also included are military engines from the French Air Force and helicopter engines. But the bulk of the business is the narrow-bodied commercial market. CFM's aftermarket civil aviation support business increased by 47% in the first half of 2022. The bulk of this business came from the CFM56. Aftermarket support is highly profitable, and the new Leap engine will have negative profit margins. Thus, Safran does well in the propulsion market.

2023 Growth

Growth in 2023 will come from the following:

• CFM currently pays penalties for late deliveries of Leap engines. Deliveries are planned at 500 per quarter, up 85% from the average of 270 in the first three quarters of 2022. The penalties should cease.
• Leap engines are increasingly using lower-cost higher technology parts to achieve the 15% cost reduction. It is reasonable to assume that 10% of the costs have been achieved, so that Leap engines in 2023 will cost 105% of breakeven.
• Service on engines in 2022 has grown about 25 to 30%.
• Airlines increasingly sign a service agreement for new aircraft, with service based on flight hours rather than time and material. This means that a new Leap engine can produce service revenue as soon as the aircraft enters service.

In 2022, Leap deliveries increased by about 30% over 2021, and Aerospace Propulsion revenue increased by the same amount. Currency and other products affected these numbers, as do lower manufacturing results. An 85% increase in Leap shipments should result in an 80% Aerospace Propulsion and a 40% in Safran profitability.

Safran Valuation

Safran is currently selling at $112 per share at trailing 12-month earnings of $10.78, for a price-earnings ratio of 10.4. A growth of 40% would increase the stock by $44.

Conclusions

Safran is a conservatively managed stock that is not widely followed. Its customers need more engines than can be produced in 2023. It is hedged against the further strengthening of the dollar. Should the dollar return to a more normal value, that would be a nice upside. Safran is a strong buy.

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