Business Breakdowns
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: Of those three categories, the wide-body engines may be slightly less share, but it's making up a big chunk of that revenue. Wide-body engines — are they any more or less profitable than narrow-body? Is there a distinction that you would make between those two categories in terms of what is maybe a higher-quality business line? [00:00:00] S1: Historically, the narrow-body side has been more scaled because of the sole-source position that they have with Boeing — which is roughly half the market — and they have significant share, nearly half to 60% share on the Airbus family. So the narrow-body has been the key driver for GE over the long term. They go to market on the narrow-body side through a joint venture with Safran called CFM International, which has been one of the most successful aviation franchises in history. In terms of profitability, there is no meaningful difference. Both wide-bodies and narrow-bodies are profitable — something like a 20% margin. Though I would guess that, just given the way the cash flows work in terms of the old fleet retiring and the new fleet coming on at different points in time, the narrow-body fleet might be more profitable for them by a few percentage points, perhaps. But despite the difference in market position, GE has done a phenomenal job in delivering roughly 20% overall margins across those programs. [00:00:00] S0: And then the military exposure as well — how would you frame that in terms of exposure and share, to the extent that they disclose that?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And then the military exposure as well — how would you frame that in terms of exposure and share, to the extent that they disclose that? [00:00:00] S1: On the military side, it's more useful to think about how many programs and platforms they are on. They have something like 25,000 engines in their fleet. This includes engines for programs like the F/A-18 Hornet/Super Hornet fighter aircraft. It also includes nearly two-thirds of all U.S. military aircraft, including helicopters. So it's a fairly diversified portfolio. One thing I would note is that GE has not been as scaled as somebody like Pratt & Whitney on the defense side. Historically, for example, they lost out on the F-35 fighter program in terms of being able to provide the engines — Pratt provides the engine there. Program by program, there can be changes. The overall market share is probably not as good a metric, and it's much more useful to look at program participation in key programs that they're on. [00:00:00] S0: Is there anything else besides those two lines that GE still has?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: Is there anything else besides those two lines that GE still has? [00:00:00] S1: They do have a defense and propulsion technologies business. So outside of their defense programs, something like 12–15% of the business is in propulsion technologies, which includes things like aircraft equipment businesses that go into both commercial and military applications. But overall, in terms of the revenue mix, commercial is overwhelmingly nearly 85% of revenues, and in terms of profitability even more pronounced. I would also add that they do report insurance revenues, which is a legacy part of GE given their intense transformation over the last few years. Less than 10% — now about mid-single-digit percent — of their overall revenues comes from insurance, though that is now in run-off. So it is not really a portion of the business where they're committing new capital. [00:00:00] S0: Just to give some scale around the revenue base today, how big are they from a top-line perspective? [00:00:00] S1: This year they'll report something like $40 billion in revenues, of which 75% is commercial engines and services and 25% is defense and propulsion technologies. Due to the difference in profitability, the commercial engine-services business is roughly 25% operating margins. The other businesses — defense and propulsion technologies — tend to be more like 11–12% margins. So in terms of earnings contribution, you're really looking at a commercial-engine franchise here in GE.
· Ramesh Narayanaswamy, Matt Reustle
[00:00:00] S1: This year they'll report something like $40 billion in revenues, of which 75% is commercial engines and services and 25% is defense and propulsion technologies. Due to the difference in profitability, the commercial engine-services business is roughly 25% operating margins. The other businesses — defense and propulsion technologies — tend to be more like 11–12% margins. So in terms of earnings contribution, you're really looking at a commercial-engine franchise here in GE. [00:00:00] S0: I assume that the way these cycles work, particularly with either replacements or new fleets coming out, you have pretty good visibility just in terms of backlog and deliveries for that revenue number and where it goes over the next couple of years. [00:00:00] S1: Absolutely. So if you look at how the aftermarket works, 70% of GE's revenues overall comes from services, which is very predictable. Spare parts revenues and services revenues from the install base. Typically engines are mandated to come in for overhauls and shop overhauls and shop resets, just from a safety and regulatory perspective. So this gives rise to an extremely predictable earning stream in the aftermarket, which also tends to be the more profitable earnings stream. [00:00:00] S0: And just on the backlog point, I understand it's a smaller percentage of revenue relative to services, but can you contextualize what backlog looks like now and maybe how that compares to history, and whatever framing that you think would be most effective?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And just on the backlog point, I understand it's a smaller percentage of revenue relative to services, but can you contextualize what backlog looks like now and maybe how that compares to history, and whatever framing that you think would be most effective? [00:00:00] S1: Absolutely. And the backlog is one of the more interesting underpinnings of GE's five- to ten-year outlook. Their current backlog is something like $175 billion on a headline basis; that's four and a half years-ish of revenues. But underneath that, there are a few nuances. So if you strip out just the commercial backlog, which obviously is the majority of the business, that's closer to six years. And within that, if you take out just the services element of revenues, which obviously is the key profit pool that GE Aerospace enjoys, that's closer to seven years. So we have a very unusually long backlog and visibility for GE. And to put it in context, this is not unusual in the supply chain. If you look at the airframers themselves, both Airbus and Boeing, with their current production rates, they are running at close to a decade's worth of backlog. So very strong visibility throughout the OE as well as the engine ecosystem. [00:00:00] S0: And relative to, let's say, five years ago, ten years ago, do those numbers in terms of four times current revenue, ten years of backlog for the airframers—is that meaningfully higher, lower, or in line with where they've been historically?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And relative to, let's say, five years ago, ten years ago, do those numbers in terms of four times current revenue, ten years of backlog for the airframers—is that meaningfully higher, lower, or in line with where they've been historically? [00:00:00] S1: I would say they're moderately higher than historical averages, but not substantially so. Aerospace generally has very long-term cycles, and that allows these companies to have significant backlogs and visibility in terms of how these engines are produced, because they need to tie in with the airframers in terms of their production. They're very closely knit in the supply chain. And secondly, because of the increasing prevalence of long-term service agreements, that has also ticked up in terms of how much the backlog gives you the visibility for. [00:00:00] S0: And for a business like GE, I can hear essentially—again, I'll use the simple numbers—somewhere in four to five times revenue in terms of backlog. So four years' worth looking out. Is that lumpy in terms of seeing major realization of backlog two years out, but maybe you have a slow year next year? Does the lumpiness drive anything, or is it realized pretty evenly over the course of those four years?