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GE Shareholders Missed the Biggest Piece of Company News From the Past Week

By Adam Levine-Weinberg - Sep 26, 2018 at 9:10PM

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A problem with a component in GE's newest gas turbine model stole the headlines last week, but it wasn't the most important piece of news about the company to emerge recently.

If you follow General Electric (GE 0.97%) regularly, you've probably heard the big news from last week. An "oxidation issue" with a component in GE's new HA-class gas turbines has forced the shutdown of several turbines, according to GE Power CEO Russell Stokes.

This revelation was followed by subsequent reports that the oxidation issue may affect up to 75 turbines of an older model and that a power plant in France is shutting down a GE turbine for a month. As a result, GE stock has plunged more than 10% over the past five trading days.

GE Price Chart

GE Weekly Stock Performance, data by YCharts.

Yet this wasn't actually the biggest news related to GE to come out over the past week. The real story should have been that CFM -- a joint venture between GE Aviation and Safran -- is finally overcoming supply chain snafus and starting to reduce delivery delays to Boeing (BA 2.90%) and Airbus. However, investors seem to have completely missed this important development.

The turbine problem isn't such a big deal

Investors are likely exaggerating the importance of the oxidation issue. While it's an unfortunate setback for the already-struggling GE Power business, "teething" issues like this are not unusual for advanced technology. The long-term impact of such issues is usually minimal.

Luckily, the affected units represent a tiny fraction of the in-service fleet of GE gas turbines. Additionally, General Electric has already identified a fix and is working with its customers to get all of the affected turbines back into service.

This suggests the problem is not very complicated. The cost to address it should be far less than the roughly $10 billion investors have knocked off of GE's market cap in the past week.

The news nobody noticed

While most investors' attention was drawn to the circus surrounding this turbine issue, a trickle of good news about production rates at GE's CFM joint venture was overlooked.

A Boeing 737 MAX 9 jet in flight

CFM is the largest producer of engines for narrowbody jets. Image source: Boeing.

As I have noted before, GE Aviation generates far more profit and has much greater growth prospects than GE Power, making it worth dramatically more than its corporate sibling. That means threats to GE Aviation's growth should be of far more concern to investors than the ups and downs of the power business. Most recently, CFM's inability to ramp up output of its new LEAP-series engines in line with its production plan has been the biggest concern in this regard.

In late July and early August, Boeing was forced to park partially completed 737 MAX jets in every corner of Renton Municipal Airport (adjacent to its production facility) due to a shortage of LEAP engines.

Luckily for both GE and Boeing, these supply issues are easing. Last week, Aviation Week reported that CFM's suppliers are finally meeting their production targets. This is allowing CFM to increase its production of LEAP engines. It has been building fewer than 30 per week recently, but hopes to boost output to 36 per week by the end of 2018. CFM is currently four weeks behind on deliveries (down from a peak of seven weeks) and management is cautiously optimistic that it will catch up over the next few months.

Furthermore, respected aerospace analyst Scott Hamilton of Leeham News and Comment wrote earlier this week that Boeing has started to reduce the number of unfinished 737s parked around its facilities. This puts Boeing on track to achieve its full-year production target, according to Hamilton -- which implies that CFM would have to at least get close to meeting its goal.

GE Aviation's ascent will continue

Last year, the GE Aviation segment produced $5.4 billion of profit on $27 billion of revenue (adjusted for new accounting rules that went into effect this year). It ended the year with an order backlog worth around $200 billion.

During the first half of 2018, GE Aviation posted a 16% uptick in segment profit on a 10% revenue increase. Orders surged 21% year over year, putting the business on pace to grow its backlog yet again this year. Due to the strong growth of air travel across the globe and the long stream of services revenue that follows jet engine sales, GE Aviation's profit could double by the mid-2020s.

An inability to ramp up output of the hugely popular CFM LEAP engine as planned could have jeopardized that growth trajectory. Thus, the fact that LEAP production is getting back on track is great news -- and far more significant for GE shareholders than the latest issues at the troubled GE Power unit.

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