GE Aerospace Q1: A Standalone Company With Strong Order Growth (NYSE:GE)

I published my bullish view on GE Aerospace (NYSE:GE) in December 2023, and suggested investor to own the stock before the spinoff. Since then, the stock has surged by 58%. On April 2^nd, 2024, GE completed GE Vernova (GEV) spinoff. The company released their Q1 FY24 result on April 23 with a 10% organic revenue growth and 14% organic order growth, raising the operating profit guidance for FY24. I am bullish on their commercial engine and defense business growth for the long run. I reiterate the ‘Buy’ rating with a fair value of $200 per share.

Notable Order/Revenue Growth and Margin Improvement

A quick summary is 10% organic revenue growth and 14% order growth, along with 300bps organic operating margin expansion. The result exceeds the market expectations; thus the company raised the full year operating profit guidance from $6-6.5 billion to $6.2-6.6 billion. As depicted in the chart below, GE Aerospace has consistently delivered double digit revenue growth and strong order growth over the past few quarters. They maintain global leadership in the attractive propulsion and after-market service markets.

They raised the operating profit guidance for the full year, as detailed in the slide below. My biggest takeaway for their Q1 earnings is the company’s efforts on cost control and margin improvement.

The adjusted operating margin improved from 6.9% in Q1 FY23 to 10.2% in Q1 FY24, which is quite remarkable. Their margin expansion was driven by several factors:

-Pricing Growth: GE Aerospace has been actively raising their service and equipment price to offset the cost inflation. While they didn’t quantify the growth from pricing increases, they indicated that pricing growth was one of the key drivers for the margin improvement.

-Spare Parts Volume Growth: Similar to other industries, spare parts usually carry much higher margin than equipment business. During the earnings call, they mentioned that spare parts experienced a quite strong growth in the quarter, resulting in margin expansion.

-Business Separation: After separating GE Vernova and GE Healthcare (GEHC), GE Aerospace has done a great job to reduce the overhead costs and improve margin for the aerospace business.

Near-Term Outlook

For the normalized revenue growth, there are several moving pieces:

– Commercial Engines & Services: According to Boeing’s (BA) report, airlines are expected to grow their fleets from 25,900 airplanes in service in 2019 to 47,080 in 2041, at an annual rate of 2.8%, with single-aisle passenger airplanes commending the largest share of new aircrafts.

I think GE will outpace the aircraft unit growth in the near future, as LEAP Engines accounted for more than 76% of total units of commercial engines sold in FY23. As indicated in my initiation report, LEAP engines have been experienced strong growth over the past few years due to industry adoptions. As illustrated in the chart below, LEAP engines nearly doubled in volume from FY21 to FY23.

– Defense & Propulsion Technologies: They manufacture jet engines for defense airframes, and the underlying growth is tied to the overall defense budget growth. As reported by the media, aircraft and combat vehicles drive growth in the Pentagon’s FY24 spending bill. Due to the increasing geopolitical tensions and regional conflicts, I anticipate the global aerospace and defense spending would accelerate in the coming years. SNS Insider projects the market will grow at a CAGR of 5.85% from 2024 to 2031. It appears reasonable to assume the market will grow at 5%-6% in the near future.

Assuming Commercial Engines & Services growing at 8% and Defense growing at 6%, the combined revenue is projected to grow at 7.5% for GE Aerospace, as per my calculations.

Valuation Revision

For FY24, I expect GE Aerospace will achieve their LDD revenue growth target as their orders surged by 25% organically in FY23. Based on their manufacturing cycle (1-2 years), their revenue growth in the near term is more likely to be strong. The global supply chain is easing in the post-pandemic era, and the manufacturing cycles should be shorter than during the pandemic period. For the normalized revenue growth, I assume 7.5% for GE Aerospace as discussed previously.

As discussed, GE Aerospace has made great efforts to cut costs and improve margins. Their SG&A expenses decreased from 16.7% of total revenue in FY22 to 13.5% in FY23, reflecting the company’s success in cutting overhead costs. During the earnings call, their management was quite confident that the company will continue to manage their costs and drive margin expansions. In addition, when LEAP Engine products start to ramp up, GE Aerospace may potentially experience better gross margins, as LEAP engines carry higher margins than traditional aircraft engines.

As such, I assume 15bps margin leverage from SG&A and 15bps from gross margin expansion. The DCF summary can be found below:

The WACC is calculated to be 9.13% assuming:

-Risk free rate: 4.25% (US 10Y Treasury Yield)

-beta: 1.09 (‘SA data’)

-equity risk premium 7%; cost of debt 7%

-debt $20.9 billion; equity $27.3 billion

-tax rate: 21%

Discounting all the FCF, the total enterprise value is estimated to be $179 billion. Adjusting the cash and debt balance, the fair value is calculated to be $200 per share, based on my estimates.

Risks

LEAP Delivery: In Q1 FY24, GE Aerospace cut LEAP delivery guidance from 20%-25% to 10%-15% for the full year. LEAP has been used on the Boeing 737 MAX and some Airbus A320neo. The guidance cut reflects the recent incident related to Alaska Airlines 737 Max 9 plane. Boeing’s 737 MAX has been problematic for a long time, and GE’s LEAP delivery is contingent upon Boeing’s ability to address their supply chain and internal quality control issues.

Separation Costs: As communicated over the earnings call, post GE Vernova spin-off, the company expects to incur $300 million in restructuring costs for corporate office wind-down and $200 million in costs for standalone infrastructures. These spendings are one-time in nature.

Conclusion

After several business separations, GE Aerospace has emerged as a highly attractive standalone business with structural growth prospects in both commercial and defense aircraft engines and aftermarket. It remains one of my long-term holdings in the industrial sector, and I reiterate the ‘Buy’ rating with a fair value of $200 per share.