American conglomerate General Electric's (GE -3.19%) focus on growing its industrial business is well known by the Street. "The aerospace segment is the place to be in industrial," says chief investment officer of Fort Pitt Capital, Charlie Smith. Exposure to the aviation industry could be a big boon for industrial companies, and GE, which derives 15% of its revenue selling aircraft engines and parts, fits the bill. Here's the lowdown on the prospects of aviation suppliers, and GE's plan of action.
Aviation suppliers thrive on growing industry backlog
Demand for commercial aircraft is increasing by leaps and bounds, riding on the growing popularity of air travel across the globe. Industry backlogs are at epic levels -- Boeing (BA -0.24%) reported 5,536 pending orders through October, while Airbus (EADSY) reported 5,860 at the same time.
To work through this backlog, plane makers are adding capacity and increasing production rates. The following chart, made by Bloomberg Intelligence in October, gives an idea about the planned production increase at Boeing and Airbus through the decade.
Source: Bloomberg Intelligence-Aerospace & Defense Team Date: Oct 8, 2014.
This signals a huge business opportunity for aircraft suppliers. "We are in the midst of a 'super-cycle' of aerospace manufacturing," said Gib Bosworth, managing director of aerospace financing at GE Capital, Corporate Finance.
GE Capital recently conducted a survey of aerospace suppliers at GE Aviation's headquarters. Approximately 84% of the respondents said that they could add jobs during the next 12 months, 91% said they expect to win new long-term supply agreements in the next three years, and 76% said that aircraft deliveries are likely to grow through 2016, at least. Boeing forecasts nearly 37,000 planes will be delivered during the next 20 years compared with a much lower figure of around 19,000 planes in the past two decades.
GE's riding on the wave
Between 2011 and 2013, GE's aviation segment's top line improved from $18.86 billion to $21.91 billion at an average growth rate of 8%, while profit rose from $3.5 billion to $4.4 billion, at a 10% clip. In 2013, aviation accounted for 15% of the company's consolidated revenue of $146 billion.
Source: GE 10Ks.
GE has reported strong margin growth in the third quarter of fiscal year 2014, ending in December, which was aided by the strength in its aviation business, among other things. The segment registered a 16% increase in profit, at $1.26 billion.
The company has an edge over its peers like Pratt & Whitney and Rolls Royce as it has a wider product range. GE serves all the three main commercial aviation segments – narrowbody, widebody, and regional. Pratt & Whitney serves narrowbody and regional aircraft, while Rolls Royce makes engines only for widebodies.
GE's having a great run with its LEAP, GEnx, and the recently launched GE9X engines. The 22.2% segment margins outperformed forecasts made by JP Morgan analysts as seen in the table below.
Plenty to look forward to
Both top and bottom lines should see significant rise in the future as GE engines are going to be an integral part of the highly anticipated Boeing 737 Max and 777X, as well as the Airbus A320neo. Through November, these three aircraft have backlogs of 2,374 units, 286 units, and 3,362 units, respectively, which gives an idea about the demand that GE engines would see during the coming years. In fact, the trend is already visible in the spectacular 34% rise in GE's aviation equipment orders to $6.8 billion in the third quarter.
Aviation Equipment Orders Strong. Source: J.P. Morgan.
The company is pioneering the revolutionary additive manufacturing technology that will allow production of complicated engine parts with greater consistency. GE is using this new technology to make 19 fuel nozzles for its latest LEAP engines. Greg Morris, leader of additive technologies for GE Aviation, said, "Today, additive manufacturing is only .02 percent of total global manufacturing, so there is a lot of opportunity going forward."
GE is enhancing its capabilities through new partnerships. It entered into a joint venture with Italy based Turbocoating SPA to offer thermal barrier coatings for CMCs that are required in aircraft engines. Delivery of the coated components is expected to begin late next year.
The company's bought a 9.9% stake in Taikoo Engine Services Xiamen that's into engine testing, component repairing, servicing GE90 engines, and more. To keep pace with its bulging volume of work, GE's also opened a new testing site at the Peebles Test Operation in Southeast Ohio to test the GEnx, GE90, GE9X and LEAP engines. The $40-million facility is slated to turn functional by year-end.
Binding it all together
Interesting times are ahead for the American conglomerate's aviation wing. With its bleeding-edge technology and relentless efforts at offering innovative products, GE stacks up well against its rivals. Aviation could be just a portion of GE's revenue, but its prospects are good enough for investors to keep the company on their radar.
