- Savings can be made from cutting bloated overheads
- Other remnants of former group can be sold off
One of the US’s most storied conglomerates has completed its break-up, as GE spun out its $33bn (£26bn)-turnover power and renewable energy business, GE Vernova (US:GEV), via a listing on the New York Stock Exchange last week.
Its disentanglement followed the hive-off of the $20bn-a-year GE Healthcare (US:GEHC) in January. What remains is a company focused on the aerospace market that chair and chief executive Larry Culp described as “maybe not as big as GE once was, but big enough”.
Culp has masterminded the transformation of GE, shaving more than $100bn off its debt pile and then sketching out the plan for this year’s split three years ago. He remains with the core business now known as GE Aerospace (US:GE), comfortably the biggest maker of jet engines in the world with $32bn of adjusted revenues.
It has a fleet of 44,000 commercial aircraft engines or almost half of the global fleet. Its share of the market is bigger than RTX’s (US:RTX) Pratt & Whitney and Rolls-Royce (RR.) combined, according to Wells Fargo Securities.
On top of this, it has a defence and propulsion technologies arm that has around 26,000 engines in service, powering General Dynamics’ (US:GD) F-16 and Boeing’s (US:BA) F-15 fighter jets, as well as the latter’s Apache and Sikorsky’s Black Hawk helicopters. Both sides of the business are growing, with increased defence spending in the US and Europe set to push global military expenditure from $1.8tn last year to $2.1tn by 2028.
It is the commercial aerospace side of the business that offers the greatest opportunity, though, with the Airbus (FR:AIR) and Boeing duopoly currently trying to ramp up production of narrowbody planes to fill orders that already stretch into the 2030s. “We really are at a point in time where demand isn't our challenge,” Culp said at an investor day last month.
GE expects to achieve “low double-digit” growth in its revenue over the next two years, and for operating profit to outpace this, increasing from $5.6bn last year to between $7.1bn-$7.5bn in 2025. By 2028, it expects to be generating $10bn of operating profit a year, with a 100 per cent cash conversion ratio.
GE’s aerospace arm “was always the crown jewel” of the former conglomerate, according to Morningstar equity analyst Nicolas Owens. It was the cash cow that allowed the group to make investments in, or prop up, other ventures.
“What had to happen for Vernova to be spun off is GE had to put several billion dollars of cash into the business in order to have it stand on its own,” he said. “[GE’s] jet engine business is an incredible business. You have 30-year visibility into lots of revenue, lots of profitability.” The company also has a wide economic moat given its technical capabilities and the high cost to airlines of switching suppliers, with much of the industry locked into long-term service agreements.
GE’s engine portfolio also has more favourable characteristics than most of its peers, according to Wells Fargo Securities analyst Matthew Akers.
Almost two-thirds of its engines are in their mid-life range (between 6 and 20 years old), which is the sweet spot in terms of higher-margin aftermarket revenues. Pratt & Whitney has more new engines, where aftermarket revenues are limited by the fact they are still under warranty, while Rolls-Royce’s engine fleet is much older. Rolls-Royce is also largely focused on the widebody part of the market but most of the anticipated growth is in the narrowbody sector powering models like Airbus’s A320neo and Boeing’s 737 Max.
GE Aerospace is also targeting a 1.5 percentage point cut in selling, general and administrative costs post spin-out but Wells Fargo’s Akers thinks there is scope for a much bigger reduction of between 3 and 5 percentage points, as the company carries more non-operations (IT, HR and finance) roles than peers – a hangover from its conglomerate structure. Then there is the “leftover stuff” it has inherited, Owens said, such as a long-term life insurance care portfolio and a Polish real estate portfolio, which can presumably be sold off.
He expects GE Aerospace to be able to generate cash flows of around $85bn over the next decade, and with the company pledging to hand back 75 per cent of excess cash to shareholders through dividends and up to $15bn in buybacks over the next three years, it should offer a steady source of income. This comes at a cost, though. GE’s share price has almost doubled over the past 12 months and the shares trade at over 33-times FactSet consensus earnings – a substantial premium over their five-year average and of peers RTX (18-times), Rolls-Royce (26-times) and Safran (28-times).
