GE Aerospace: First Standalone Results Back Up Premium Valuation

I initiated my coverage of GE Aerospace (NYSE:GE) following the long-awaited spin-off of General Electric’s last remaining other division, Vernova, in early April. Since then, shares have continued their strong performance, being up ~12% vs. roughly flat peers. Despite my last note being only one month old, I believe it is appropriate to update my thesis given the significant post spin-off buzz and the company’s first standalone earnings.

GE Aerospace reported its performance for the period ended March 31 last week, beating consensus on top and bottom line and raising its full-year profit guidance. On the back of continued strong operational momentum and surging orders with company level YoY growth of 34% and 78% growth for original equipment (“OE”), I reiterate my Outperform rating. Applying an updated 28x multiple (~10% premium to the closest peer and CFM JV partner Safran) on my new forecast of $7.15 in 26E FCF/sh, I raise my price target by 21% to $200, implying further ~23% upside through YE24.

[Note: Peers refer to Safran (OTCPK:SAFRF), RTX (RTX) and Rolls-Royce (OTCPK:RYCEY). All financials and company projections from the Q1 earnings release and investor presentation.]

Earnings Snapshot

For Q1 24 GE Aerospace reported total adjusted revenues of $8.1B, up 15% YoY driven by stronger pricing, higher volume of spare parts and an increase in engine deliveries. Similar to a trend observed at peer RTX and in line with management communication, top line benefitted significantly from strong OE sales development at +20% YoY, while aftermarket (services) growth came in below corporate at +14%. Operating profit climbed 24% to $1.5B as margins increased 140bps to ~19% with positive contributions from pricing, services volume and an overall more favorable mix. Free cash flow for the quarter came in at $1.7B, doubling YoY due to higher net income and positive working capital effects driven by strong collections and progress payments, while inventory was noted to have been a net headwind. Conversion vs. net income was ~160%, in line with full-year guidance of >100% conversion.

Net new orders came in at $11B, up 34% vs. Q1 23 for a healthy corporate level book-to-bill ratio of ~1.4x and a stellar 1.9x for OE, driven by significant order flow and confirming my thesis of a beginning shift from aftermarket to OE activity as laid out in my comment on RTX’s Q1. Engine and other original equipment orders across both segments surged by almost 80% YoY driven by significant new order flow for GE’s next-gen engine families of LEAP and GEnx while service orders grew 14%.

Consolidated backlog grew ~11% YoY and declined slightly vs. Q4 23 to end the period at $153B, of which ~$18.4B in OE and $134B in services. Compared to the prior year’s Q1, OE backlog grew by ~$2B or 13% while the value of outstanding services declined slightly by 2% (~$3B).

Other notable developments during the quarter included $0.1B in share repurchases and cash proceeds of $2.6B from a further reduction in the company’s stake in GE Healthcare. The company also increased common dividends by ~250% to ¢28 per quarter or $1.12 per year respectively for a current yield of 0.7% at a 30% payout ratio.

Commercial Engines & Services (“CES”) – Revenues grew 16% YoY to $6.1B with volumes up LDD and better pricing. Similar to corporate level revenues, OE performed stronger than services at ~31% YoY growth due to higher deliveries and pricing. Management notes that the majority of delivery growth was contributed by wide body engines including the GEnx while LEAP deliveries were flat YoY at 367 units due to supply chain issues. Revenue from services grew 12% YoY as higher material costs were more than offset by pricing, spare parts volume and 3% higher shop visits.

Net orders for the segment increased 34% YoY to $8.3B for a book-to-bill of 1.4x, as order flow for both OE and services grew by double-digits, largely driven by strong demand for the LEAP engine and spare parts. In terms of mix, management notes highly positive customer dynamics, with strong order contributions from both airlines and airframers. Notable business wins during Q1 include a fixed order of 45 GEnx engines for Thai Airways, a commitment from easyJet to purchase more than 300 LEAP engines and a servicing agreement with American Airlines for 400 LEAP engines.

Operating income for Q1 was $1.4B, up 17% YoY with margins at 23.3%, up 10bps from pricing and higher share of spare parts in overall sales mix which offset a ~$200MM negative impact from lower estimated profitability on long-term service agreements.

Defense & Propulsion Technologies (“DPT”) – The segment reported Q1 revenues of $2.3B, up 18% vs. Q1 23 on a YoY delivery growth of 45 engines, better pricing and growth in additive technologies. Orders were up 34% YoY to $3B, driven by strong demand and implying a quarterly book-to-bill of 1.3x for the segment. Management cited several business wins during the quarter, with the most significant being a F414 engine order of undisclosed value by the Korean Air Force. Operating income came in at $0.3B, up 26% YoY, with margins expanding 80bps to 11%. The increase was driven by both volume and pricing, which offset an unfavorable mix.

Full-year guidance – As part of the call and on the back of the strong operational and financial performance during the quarter, management also updated its full-year guidance. While continuing to expect revenue growth in the LDDs, GE raised its profit guidance from a previously expected range of $6.0-6.5B to $6.2-6.6B, a ~2% increase at midpoint and driven by higher estimated profitability at CES and a margin expansion of ~50bps (previous guidance: flat). Management noted that this higher profitability would be in part achieved by a higher mix of aftermarket as of CES segment sales, with FY24 LEAP engine delivery growth forecast cut to ~10-15% YoY from ~20-25% on ongoing production issues at Boeing.

Adjusted EPS for the standalone company was also first guided to lie between $3.80 and $4.05 implying a more than 30% YoY growth. FCF for the year remained at an expected >$5B, with a forecasted net income conversion upwards of 100%. Management also provided additional visibility into the company’s capital spending outlay, announcing to invest over $650MM in manufacturing and supply chains, of which $550MM will consist of site upgrades domestically and internationally and $100M will be used to improve supply chain resilience.

Risks – Key risks to my thesis remain in worsening global economic conditions and consumer health impacting flight hours and airline procurement, as well as company-specific supply chain and quality issues. I note that at the premium valuation GE is currently holding, any small setback or issue could significantly re-rate multiples. There also remains the potential for the ongoing production issues at Boeing to further hurt LEAP delivery trajectory, with management having already adjusted full-year guidance downward to account for lower LEAP 1-B (Boeing variant) deliveries.

Valuation Update

Flowing through Q1 results, the updated guidance and higher estimates on FCF conversion through my model, I raise my FCF/sh projections for 24E/25E and 26E to $4.90/$6.19 and $7.15 respectively. I further increase my projections for dividend growth through 28E to a CAGR of ~23%, based on higher expected net income and a gradual rise in payout ratio from 30% to 40% by 28E. My estimates for share buybacks remain consistent at ~12% of currently outstanding stock over the next five years.

On the back of the company’s continued strong execution, I also raised my target multiple on 26E FCF/sh from previously 25x to 28x, implying a ~3.6% FCF yield. I note that this represents a 40% premium vs. the consolidated peer group and a ~10% premium to the closest peer, Safran which, I believe, is justified given GE’s superior margins, higher share of service revenues and return on assets.

Applying a 28x multiple to my 26E FCF/sh estimate of $7.15 I raise my price target by 21% to $200/sh, implying ~23% further upside potential through YE24.

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