Summary of GE Aerospace: Full Throttle - [Business Breakdowns, EP.235]

Overview of GE Aerospace: Full Throttle — Business Breakdowns (EP.235)

This episode of Business Breakdowns features Matt Russell interviewing Ramesh Narayanaswamy (co‑founder & PM, Tubian Partners) about GE Aerospace after GE’s de‑conglomeration. The conversation focuses on what GE Aerospace actually does (jet engines for commercial and military aircraft), why the business is unusually durable and cash‑generative (large installed base + high‑margin aftermarket services), how the industry structure (few credible engine makers, large airframer bargaining power) shapes economics, the key growth drivers and risks, and what this teaches investors about scarce, long‑cycle franchises.

Key points & main takeaways

• GE Aerospace is effectively the crown‑jewel pure‑play engine business after GE’s spinoffs; the enterprise is a highly visible, service‑heavy franchise with long backlogs and predictable cash flow.
• Engines are sold at very low/negative margins on the OE sale (to airframers); the real profit is in aftermarket services and spare parts over decades.
• Industry economics are shaped by very high technical and regulatory barriers, concentrated OEM customers (Boeing/Airbus/COMAC) and consolidated engine suppliers (GE/Safran via CFM JV, Pratt & Whitney, Rolls‑Royce, MTU).
• Structural durability comes from mandated maintenance cycles and long asset lives (engines and airframes), making the installed base akin to a bond‑like cash flow stream.
• Key risks are technical reliability/time‑on‑wing, cycle timing & OE production rates, competitor technology success (e.g., P&W GTF), and long‑term technology bets (open‑rotor/open‑fan).

Company & business model

• What they sell: jet engines and related services for commercial aviation, defense, regional and business jets; also propulsion technologies and some legacy insurance runoff.
• Installed base (correcting transcript errors): ~70,000 engines in service globally — roughly ~45,000 commercial and ~25,000 military (approximate).
• Revenue mix (approx.): ~$40B of revenue run‑rate; ~75% commercial engines & services, ~25% defense/propulsion tech; services account for the majority of profitable revenue.
• Profit mix: Commercial engine services generate the bulk of operating profit (service margins much higher than OE margins).

Market structure & competitive dynamics

• Duopolistic/oligopolistic supply: Only a few OEMs can compete at scale — GE (with Safran through CFM International JV), Pratt & Whitney, Rolls‑Royce, MTU. High barriers: extreme materials/thermal engineering, certification, scale.
• CFM International (GE + Safran, 50/50 JV): historically one of aerospace’s most successful partnerships. GE traditionally handles the “hot” section; Safran more on the “cold” section — but economics are shared.
• Airframers (Boeing/Airbus/COMAC) are powerful purchasing customers: OE engine sales are heavily discounted; airframers can dictate sole‑source vs dual‑source strategies.
• Two distinct customer groups:
  • OE buyer (airframers): buys engines at steep discounts (often loss‑leading).
  • Long‑term user (airlines/lessors): pays for spare parts & maintenance over decades → primary profit source.

Financials, backlog & cash dynamics

• Backlog: Headline backlog ~ $175B — roughly 4–5 years of total revenue on a headline basis. Commercial backlog closer to ~6 years; services backlog gives ~7 years of visibility on services revenue.
• Services: ~70% of revenue (industry and company averages vary by segment) and are highly predictable because shop visits and mandated maintenance are non‑discretionary.
• Margins:
  • Aftermarket/service margins are very high (gross margins in the aftermarket can be large; operating margins for commercial engine services often in the 20%+ range).
  • Defense/propulsion technologies are lower margin (~11–12%).
• CapEx & cash conversion:
  • Reported CapEx ~ <3% of revenue (low headline capex in harvest phase).
  • Strong FCF conversion historically — many peers (e.g., Safran) generated positive FCF even in COVID.
  • Adjusted return on tangible operating capital estimated ~20–25% (after stripping pensions, goodwill, contract assets/liabilities).

Revenue model & aftermarket mechanics

• OE sales:
  • Engines priced high at list (tens of millions), but sold at deep discounts to airframers while programs are ramping — often loss or breakeven until mature.
  • Example: LEAP list prices ~$20–22M; GE’s recognized revenue per engine is much lower once discounts applied.
• Aftermarket:
  • Two models: time‑and‑materials (pay when shop visits occur) and long‑term service agreements (e.g., “power‑by‑the‑hour” / per flight hour subscription).
  • Long‑term service agreements shift risk to OEM (engine maker) but offer steadiness of revenue.
  • For LEAP: ~60% under long‑term contracts; ~30% of revenues are power‑by‑the‑hour (numbers approximate).
  • Aftermarket profitability drives value: spare/maintenance revenue over an engine’s life can be several times the OE sale and delivers high margins.
• Backlog conversion: services convert relatively steadily; OE revenues are lumpier, tied to aircraft production rates and OEM schedules.

Growth drivers and outlook

• Aviation demand:
  • Long‑term passenger traffic (RPKs) typically grows mid‑single digits; emerging markets grow faster.
  • Airbus/Boeing production backlogs extend many years (airframers often have ~10 years of backlog), supporting future OE demand.
• Specific GE drivers:
  • LEAP program is young (entered service ~2016) and is replacing CFM56 — eventual fleet size and more shop visits imply multi‑decade aftermarket growth.
  • Aftermarket pricing has been strong post‑pandemic and could sustain mid‑single digit annual pricing growth.
  • Ramesh’s view: commercial services revenue growth could be ~8–10% annually with high visibility for the next 5+ years; defense growth more modest (~4%).
• Technology bets:
  • GE is pursuing open‑fan / open‑rotor architectures for next‑gen efficiency gains; higher reward but higher technical risk compared to geared turbofan approaches (P&W).

Key risks & red flags

• Reliability / time‑on‑wing: newer engine families take time to reach the reliability of predecessors. Problems (e.g., Pratt & Whitney GTF earlier issues) can reduce airline confidence and create operational disruption.
• Competitor technology & market share shifts: if competitors fix issues or offer superior economics, market share can change over decades (historical precedents exist).
• OE production volatility: airline demand, airframer production rates, or supply‑chain disruptions can create lumpier OE revenue realization.
• Boeing/Airframer negotiating leverage: sole‑source relationships can change; Boeing may revisit sole‑source choices on future narrowbody programs.
• PMA/aftermarket entrants: threat is limited for engines (technical & warranty barriers), but remains a long‑term watch item.
• Long development cycles / heavy early investment: development losses on new engines can be massive; returns accrue over many years.

Management, capital allocation & corporate history

• Larry Culp (CEO) led de‑conglomeration: spun off Healthcare and Vernova, focused the company on aerospace, improved operational culture using lean/Kaizen principles, emphasized capital returns and debt reduction.
• Management governance: pivot from a diversified GE to focused, higher‑quality aerospace franchise; compensation tied to performance targets (large one‑time grants historically).
• Capital allocation: stated plan to return excess cash (management has emphasized ~70% return of excess cash); dividends and buybacks are primary distribution tools (dividend ≈30% of distributions; rest via buybacks).
• Cultural change emphasized: “common sense vigorously applied” — focus on operational rigor and customer service.

Valuation & investor considerations

• Valuation frameworks:
  • Installed base valuation: treat engines like long‑dated cash instruments — NPV per engine approach can be used in stressed scenarios (useful during crises).
  • Normal‑cycle multiples: FCF/earnings multiples are common in mid‑cycle; Ramesh notes GE trading around ~40x FCF at the time of discussion (reflecting optimistic growth expectations).
• How to think about a purchase:
  • Look at backlog converting (services versus OE), LEAP OE profitability improvements over time, time‑on‑wing trends, and competitor remediation (P&W fixes).
  • Monitor production rates at Airbus/Boeing and any changes to sole‑source arrangements.

Notable quotes & insights

• “Selling services attached to equipment” — the aftermarket economics (multi‑decade, high margin) are where engines actually make their money.
• “Bifurcation of the buyer and the user” — airframers buy engines as OE customers; airlines use and pay for service; this dual‑customer structure strengthens barriers to entry.
• Larry Culp’s approach summarized as “common sense vigorously applied” — cultural and operational discipline matters as much as technology.
• Scarcity drives value: very few companies globally can credibly build and support jet engines at scale — that scarcity underpins long‑term economics.

Actionable signposts / what to watch

• LEAP program: OE margin trajectory (losses shrinking → breakeven), ramp stability, and spare parts pricing.
• Time‑on‑wing metrics and shop visit frequency for LEAP fleet (reliability improvements).
• P&W GTF remediation progress — if P&W regains credibility, narrowbody aftermarket composition could shift.
• Airframer production plans (Boeing/Airbus) and any shifts in engine sourcing policy (sole vs dual sourcing).
• Backlog composition: services vs OE, and conversion rates into revenue/FCF.
• Management capital return execution (dividends, buybacks) and reinvestment in next‑gen tech (open‑fan development milestones).

Lessons for investors & operators

• Durable franchises can hide in technical, long‑cycle industries where scarcity, regulatory lock‑ins, and aftermarket economics create predictable cash flows.
• Focus and operational culture (de‑conglomeration + disciplined execution) can crystallize latent franchise value.
• When buyer and user are decoupled, incumbents can sustain advantageous economics through contractual/operational lock‑ins.
• Valuation should consider both steady‑state cashflow multiples and the installed‑asset NPV perspective — the latter is especially useful during stress cycles.

Final note: GE Aerospace exemplifies a business where extraordinary technical barriers, long asset lives, and high‑margin aftermarket services combine to create a durable, highly visible cash flow stream — but it is not without multi‑decade technology and reliability risks that require ongoing capital and operational excellence.