The slowdown in deliveries at Boeing is good news from a near-term profit perspective at its engine supplier. It will also lead to more aftermarket revenue from its legacy engines.
GE Aerospace (GE 0.68%) has delivered stellar returns for investors, but is the party over now?
Putting aside the stock chart, GE trades on slightly more than 40 times the midpoint of management’s earnings guidance for 2024, making it look expensive on a near-term earnings basis. As such, is there still a case for buying the stock?
GE Aerospace’s earnings cycle
The investment case for the stock rests on the life cycle of its most important product: airplane engines. They are typically sold at a loss, only to generate decades of lucrative aftermarket revenue as engines are utilized and periodically come in for so-called “shop visits.” A shop visit is when an engine is brought in for maintenance, repair, and overhaul (MRO).
For a flavor of how this works in practice, engines can run for more than 40 years. GE’s management estimates that new engine development and sale only account for 25% of the life cycle revenue on a typical engine. The first, second, and third shop visits (spread over many years) account for 20%, 30%, and 25%, respectively.
GE’s most important engine is the LEAP (produced by its joint venture with Safran, CFM International), the sole engine option on the Boeing 737 MAX and one of two options on the Airbus A320 neo family of aircraft – the two narrow-body workhorses of the skies. As production of these two relatively new airplanes ramps up, so will LEAP engine production.
As the newer airplanes gradually replace the legacy Boeing 737 and Airbus A320 family of airplanes, LEAP utilization will grow relative to the engines used on the legacy planes, including CFM International’s CFM56.
This means GE will experience a period whereby still substantial aftermarket revenue on the CFM56 will peak and then be replaced by LEAP aftermarket revenue as the latter is utilized more. Digging into the details of the recent Investor Day presentation, a few disclosures were made that investors need to reassess in light of the recent results:
GE Aerospace’s operating profit margin will be flat in 2024 compared to 2023, partly due to negative pressure on margins from a 20%- 25% ramp-up in LEAP production.
CFM56 services revenue will peak in 2025 but remain strong, as 45% of the CFM56 fleet hasn’t even had its first shop visit yet.
CFM56 revenue will still decline from 2025, and growth in LEAP services revenue will lead to comparable revenue from the two engines in 2028.
GE’s margin pressure in 2024 will ease as LEAP aftermarket/service revenue grows.
Image source: Getty Images.
The updated view from GE Aerospace’s first-quarter earnings
The bullet points from GE’s investor day presentation need some consideration in light of delivery delays on the Boeing 737 MAX, resulting in GE changing its LEAP production targets in 2024:
GE’s operating margin will now expand compared to 2023, and management now expects operating profit of $6.2 billion to $6.6 billion, compared to a previous estimate of $6 billion to $6.5 billion, partly due to only ramping LEAP production by 10%-15%.
CEO Larry Culp said that the peak of CFM56 services revenue would now be pushed out (as older engines are run more, given the reduced expectation for Boeing 737 MAX production), but he didn’t speculate on the exact timing.
Ultimately, there is a slight change in near-term expectations, but the long-term dynamics remain the same.
What it means to GE Aerospace investors
Just as investors shouldn’t get too excited by the increase in earnings guidance for 2024, they shouldn’t focus too much on the absolute level of earnings this year. Despite the reduction in LEAP production expectations (which helps near-term profits), it’s still a year when a ramp-up in low- or negative-margin equipment production will constrain margin expansion.
Instead, investors should focus on management’s medium-term outlook for operating profit to grow significantly from $6.2 billion to $6.6 billion in 2024 toward $10 billion in 2028, as LEAP services revenue starts to kick in. Investors can look forward to long-term margin expansion after that.
As such, based on the current market cap, GE’s price-to-operating earnings multiple will drop from 28 times in 2024 to a more reasonable 17.4 times in 2028. That’s not the cheapest valuation, but it suggests a little upside in GE’s stock price.
Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
