Key points
- Ramesh Narayanaswamy says GE Aerospace's aftermarket, not engine sales, drives value, with engines sold to Airbus and Boeing at deep discounts before profits arrive through spare parts and services.
- GE Aerospace expects about $40bn in revenue this year, with 75% from commercial engines and services and roughly 70% of total revenue from predictable, regulator-mandated services.
- Ramesh Narayanaswamy argues that high barriers to entry and mandated maintenance insulate GE, Pratt and MTU from downturns, while airlines remain exposed to cyclical swings.
GE Aerospace sells engines cheap and earns decades servicing them
GE Aerospace earns its money after the engine is sold. Engines go to Airbus and Boeing at deep discounts, then airlines must service them for decades with parts only the maker supplies. A huge installed base and very high barriers to entry make that stream predictable, and a leaner post-breakup GE converts it into cash.
Takeaways
- Aftermarket service, not engine sales, drives the profit. Engine makers sell to Airbus and Boeing at discounts of up to 70 or 80%, taking losses until spare parts pay back five or ten years later. Over an engine's life the aftermarket can be three to five times the original sale, at roughly 60% gross margin.
- GE's installed base is enormous and dominant. GE has about 70,000 engines in service, 45,000 commercial and 25,000 military, powering roughly three of four commercial takeoffs. The CFM56 is on every Boeing 737 and the LEAP is sole-source on the 737 MAX and COMAC C919. Share is about 70% in narrow-bodies and 50% in wide-bodies.
- Regulation makes services revenue unusually predictable. About 70% of the roughly $40bn in revenue comes from services, because regulators mandate overhauls. Backlog is about $175bn, or four and a half years of revenue, and nearer seven years for services. Commercial services earn about 25% margins, against 11 to 12% in defense.
- Engine making has very high barriers to entry. Jet engines are among the hardest engineering challenges and cost billions to develop, so only a few firms build them at scale. GE's CFM joint venture with Safran is about 50 years old. Spare-part rivals struggle, and Pratt's PMA attempt on the CFM56 failed.
- Growth looks steady and downturns are cushioned. Ramesh expects air travel to grow about 1.5 times GDP, faster in emerging markets, with LEAP growth offsetting CFM56 retirements. He forecasts commercial services growing 8 to 10% a year and defense about 4%. Mandated maintenance insulates engine makers, while airlines at 83 to 84% load factors stay exposed.
- Culp's discipline and portfolio pruning lifted returns. Most reported margin expansion came from portfolio rationalization, about 500 basis points under Larry Culp. He was GE's first outside CEO and brought Danaher's lean approach. Capex is under 3% of revenue, free cash flow conversion near 100%, and return on tangible capital 20 to 25%.
- Risks are reliability, dual-sourcing and open rotor timing. Pratt's GTF shows how reliability problems can hurt. Boeing could dual-source its next narrow-body, and GE's open-rotor bet may be a decade away. At about 40 times free cash flow, valuation mostly reflects where the industry sits in its cycle.