General Electric is on a path characterized by cash generation, reinvestment in its core operations, and a commitment to maximizing shareholder return.
On April 2, 2024, General Electric Verona, or $GEV, will become live and tradable on the New York Stock Exchange. This new entity, spun off from General Electric GE 0.00%↑ will focus on manufacturing components and generators for power grids.
I find GEV less compelling due to its low profit margins of 6-8%, cyclical nature, and significant capital expenditure requirements. However, the remaining part of GE —trading as $GE presents a more interesting opportunity. This streamlined version of GE will primarily comprise General Electric Aerospace, which, based on the released financials, appears to be excellent.
GE Aerospace's dominance in commercial aviation is undeniable. Over 75% of commercial flights rely on GE engines, used by both Boeing and Airbus. This diversification ensures stability even as airlines may switch between manufacturers. On average, aircraft using their engines are young, and have many years of service left. This is important since 70% of the $32 billion revenue in 2023 came from services.
Services are a recurring income stream, allowing the company to be strong.
The defense sector accounts for 40% of GE Aviation's business. As partners in several next-generation combat aircraft programs, and with global defense spending on the rise due to geopolitical tensions, GE is poised for sustained growth in this area.
The thesis for GE hinges on the market potentially mispricing the company amidst the upcoming spin-off confusion and the growth under the leadership of H. Lawrence Culp Jr. With a forecasted $10 billion profit and a commitment to 100% free cash flow conversion by 2028, coupled with plans for substantial dividends and buybacks, GE is set up well to provide healthy shareholder returns.
Commercial
There’s no question about GE Aviation’s domination of the commercial aviation industry. “In 2023, about 3 billion passengers flew on flights depending on GE technology, and three out of four commercial flights were powered by their engines”
While some of this market share is for GE Aviation’s own engines, most of this market share is accounted for by CFM International, which is a 50/50 joint venture between GE Aviation and the French company Safran.
Since the pandemic ended, people have started to travel again, and commercial aviation is growing. As the dominant supplier to the airline industry, GE aerospace is poised to grow with it. An important point to note is that, for GE, the sale of a new aircraft is just the start of the revenue stream. By government regulations, engines must be consistently inspected and serviced to promote safety and reliability. This presents GE with an ongoing stream of rich revenue.
In addition, jet engines are a “moat” business. Airlines are “locked” into continued use of GE engines because, as a critical component of the airplane, any switch to a rival engine would result in the need for expensive recertification testing.
Another strength of GE’s aviation business is the diversification they have, among a large portfolio of different airplane models, which cover different market segments:
As the above diagram illustrates, new engine sales are just the tip of the iceberg, and there will be an enormous amount of parts & service revenue which accrue over a 40+ year product lifespan. These elements serve to insulate GE Aerospace from any extreme fluctuations due to macro economic cycles, as well as micro economic cycles inherent in any individual airline industry segment.
The best selling engine in the airline business is the CFM56 engine from CFM. The first version of this engine went into service in 1982. It has now logged over 1 billion flight-hours of operation. CFM is now delivering the CFM56 successor line of engines called LEAP. They are also developing a sustainable engine called RISE, which uses hydrogen and sustainable aviation fluids.
GE Aviation’s roadmap is to continue service and safety for the CFM56 today, sell improved efficiency and durability in the near future with LEAP, and eventually move into super efficiency and sustainability with RISE. This means that GE isn’t content to simply sit passively and milk their existing products, but are investing in innovation, and planning to stay relevant into the future.
Defense
Accounting for 40% of its revenue, the defense industry represents a critical segment of GE's operations.
The geopolitical climate allows General Electric to capitalize on secular trends, with expectations of the U.S. defense budget growing by low single digits (LSD) and the rest of the world by mid single digits (MSD). GE projects its defense revenue to increase annually by 6-8% over the next five years, bolstered by its partnerships in leading next-generation fighter programs.
Specifically, the bulk of their revenue is driven by Defense and Systems, with the remainder coming from Propulsion and Additive Technologies.
GE's defense offerings are diverse, covering fighters, helicopters, and naval vessels across various countries. The revenue breakdown includes 40% from combat aircraft, 25% from rotorcraft, 20% from marine applications, and 15% from other areas, such as computing and navigation systems.
High volume increases are anticipated across both domestic and international markets, particularly in combat fighters, where GE foresees significant growth in international orders.
Edison Works
Edison Works, GE's dedicated research center, plays a pivotal role in maintaining the company's competitive edge in technology and innovation. This focus ensures GE's ongoing capability to supply advanced engines for next generation planes and aircraft. Edison works is not a money sink. In 2021 approximately $300 million in revenue was generated, and they plan on reaching close to $1 Billion by 2028.
P&AT
In 2023, propulsion and additive technologies accounted for roughly 35% of GE's revenue, or $3 billion, primarily supporting countries outside the USA.
About 40% comes from subsidiaries and business units which create gearboxes, supply parts to the Italian military and operate as an Original Equipment Manufacturer (OEM).
The remainder, 60%, comes from Avio Aero, a GE Aviation subsidiary which is a trusted partner by European Nations and creates engines and more ( design to service, MRO etc)
Avio Aero is trusted by governments worldwide as partners for their programs. Their global trust is seen by its involvement in the Global Combat Air Programme, a multinational effort valued at over 40 billion euros to develop a sixth-generation stealth fighter. This collaboration between England, Japan, and Italy aims for a prototype by 2027 and full production by 2035.
Such partnerships position Avio Aero for future collaborations on planes or drones, driving potential growth.
As European nations respond to ongoing conflict by increasing their arms capabilities, Avio Aero's ITAR and EAR-free engines—free from the U.S. Department of Defense restrictions—become increasingly valuable. This enables the supply of essential technology for projects like the Eurodrone.
With expected growth from MSD to HSD by the end of 2024 and a forecast of HSD growth over the next five years, the operating profit in this sector is poised for even faster expansion, potentially reaching the low teens.
Avio Aero is expected to be a leading contributor to General Electrics continued success for the future.
Financial
At the end of 2023, and taking into account the spin-off, General Electric reported an operating profit of $5.6 billion, alongside $4.7 billion in free cash flow. Looking ahead to the end of 2024, the company has set its sights on achieving low double-digit revenue growth, aiming for an operating profit in the range of $6 to $6.5 billion.
The 17.4% profit margin displayed above, is significantly superior to what GEV can generate.
By 2025, projections suggest an operating profit between $7 and $7.5 billion, with a free cash flow conversion exceeding 100%, largely due to depreciation factors. GE's strategic roadmap for this growth encompasses two main avenues: price adjustments to account for inflation and innovations in its engine lineup. The CFM International LEAP engine is going to be the main contributor to this increase. They expect this engine to overtake the CFM 45 engine ( which was created in 1974) in profit by 2030. The forecast also includes a 2x increase in shop visits and a significant uptick in service revenue.
In five years, this is the plan:
GE is a strong business. It is a cash cow, and expects high growth. Assuming these targets are met, buying post spin off could end in a favorable outcome.
Management + Buybacks
General Electric is on a path characterized by cash generation, reinvestment in its core operations, and a commitment to maximizing shareholder return. At the helm of this is H. Lawrence Culp Jr., who served as CEO of Danaher DHR 0.00%↑ from 2000 to 2014.
Knowing this, only one thought goes in my head: "You can take the man out of Danaher, but you can't take Danaher out of the man" - Anshul 2024
Danaher is known for practicing the KAIZEN method which is a concept for continuous improvement. This thought process seems to have transitioned to GE under his stewardship.
Terms like "Flight Deck," symbolizing lean operations, and "Hoshin Kanri," a strategic planning method signify a deeper strategic integration of KAIZEN principles into GE's DNA.
In conglomerates like GE, adopting such a culture can significantly influence overall performance. It is hard to put a hard number on the impact, but looking at Danaher and others who practice this thinking, it certainly has some impact.
Valuation
It’s hard to know what the market will value GEA at until the spin off. The snapshot for GEV is on March 19th, with the full spin off on April 2nd.
My main way to valuing is to take a look at the free cash being generated, and the multiple.
I’ve compared numbers released/projections from 2023 to 2025 for both Safran and GE (Aerospace)
I’ve also added TransDigm and Heico. (They aren’t true competitors but think it is worth seeing at least 2023’s data)
31x is not necessarily cheap by any means, but it is cheaper than peers.
End Game
GE is a great business that may face a draw down, or trade at a more attractive valuation once the GEV spin off is completed.
This document is provided for informational purposes only. Past performance is not indicative of future results. This should not be considered financial advice. The author holds or plans on holding shares in the companies mentioned above.
Thank you “Yerd” for the help.