Moat Monster: GE Aerospace’s Rise Is Just the Beginning (NYSE:GE)

introduction

I have to say I don’t have many regrets when I think about the investments I’ve made in the past few years. I still own most of the companies I’ve bought for my dividend growth portfolio since the pandemic I never sold anything at a loss. While this may sound a bit arrogant, note that I have an investment horizon that spans several decades when I invest. My turnover is very low.

However, my biggest regret is the stocks I didn’t buy – especially the stocks I gave away (Strong deal classification in the past. One such company is General Electric, which now bears its name GE Aerospace (New York Stock Exchange: GE) After separating all non-space sectors.

My last article was written three months ago when I wrote: “45% Up Since October: Is GE’s Rally Sustainable?”

Since then, GE shares have risen another 30%! It is now up 92% since I restarted coverage on June 10, 2023.

Writing this gives me mixed feelings. I was right, but I missed the entire rally because I didn’t want to add more exposure to my portfolio, which already included 22% exposure in aerospace and defense.

In this article, I’ll update my thesis and explain why I’m determined to buy GE stock this time around – regardless of my senior position in the industry.

So lets get to it!

A giant wide trench in the right place at the right time

On May 23, I wrote an article entitled Higher for longer? 3 of my favorite dividend stocks that I expect will continue to rise. GE Aerospace is included.

In this unfocused article, I discuss one of the things that stands out when dealing with this aviation giant: its moat.

Economic moat is a metaphor that refers to the ability of companies to maintain a competitive advantage over their competitors in order to maintain market share and profits. Any method a company uses to maintain a competitive advantage can be considered an economic moat. – Investopedia

GE Aerospace is a company with wide moats. In fact, I would point out that there aren’t a lot of companies that have bigger moats.

One reason is research and development (“R&D”). Research and development in aviation is what drives innovation.

In GE’s case, the company is leveraging its major defense footprint, powering aircraft like the F-15 and F-16 through its F-110 engine platform. This makes the company a key partner for the government, benefiting research and development.

Using last year’s numbers, GE Aerospace spent $2.3 billion on research and development! Of this, $1.3 billion was funded by customers and partners – and this is almost exclusively from the US government.

This innovation paves the way for an advantage in commercial aviation.

Even ignoring R&D, it is difficult to compete with the company’s relationships with governments and airlines, where it has been a trusted partner for many decades. Furthermore, replacement, maintenance, and complexity add to their trenches.

Although commercial aviation has been mainstream for more than 60 years, the ability to produce highly complex engines is still limited to a few global players.

For example, the GEnx engine includes more than a million parts that rely on a highly complex supply chain that spans multiple countries.

Furthermore, in the wide-body engine market, the company has a duopoly, with an overall engine market share of 14%, which excludes its joint venture called CFM International, which has a 39% market share.

General Electric estimates that three-quarters of commercial flights are powered by GE or common GE engines. Its joint venture, CFM International, supplies 100% of 737 MAX engines and 60% of A320 engines, and also independently supplies wide-body and regional engines. Its large engine base provides ongoing, predictable revenue through maintenance, repair and replacement components independent of new aircraft deliveries. – Standard & Poor’s International

When you add that the company makes up to 65-70% of the total engine value through aftermarket sales and maintenance over the life of the engine, we get a stronger moat that is almost impenetrable to new entrants.

After all, not only are engines getting better, allowing them to be used longer, but we’re also dealing with a rapidly expanding installed base!

According to Research & Markets, the commercial aircraft aftermarket is expected to grow 5.8% to reach approximately $70 billion by 2032.

Furthermore, Airbus SE ( OTCPK:EADSF ) expects demand for approximately 41,000 new aircraft through 2042 – with less than half of these aircraft being replacement aircraft!

Better yet, with the pandemic behind us, we will return to “normal,” which is increased demand for commercial aviation.

As reported by Reuters on June 3 (emphasis added):

The International Air Transport Association (IATA) said it expects the global industry to make profits of $30.5 billion this year, higher than the upwardly revised $27.4 billion in 2023, as carriers keep a lid on essential labor costs despite recent strikes.

This comes just four years after the industry collapsed to a loss of $140 billion in 2020 as a result of the pandemic, which is higher than the $25.7 billion forecast for 2024 issued in December.

“The environment is better than we expected, especially in Asia,” Director General Willie Walsh told Reuters on the sidelines of the annual meeting of the International Air Transport Association, which includes more than 300 members representing more than 80 percent of global air traffic.

While the road ahead will have some bumps and hurdles, I have no doubt that commercial aviation is still the place to be for high long-term gains. This is also true for GE Aerospace – despite its recent rise.

The risk/reward remains good

Combined with the company’s wide-ranging characteristics and long-term demand that we discussed in Part 1 of this article, the company is knocking it out of the park financially.

For example, in the first quarter, the company recorded significant growth across all key metrics:

• Orders rose 34%, with revenues up 15%. This was driven by pricing, increased spare parts volume, and increased deliveries of wide-body and defensive engines.
• Operating profits rose 24% to $1.5 billion, with margins expanding 140 basis points to 19.1%.
• Free cash flow also doubled to $1.7 billion.

In addition to generating plenty of free cash flow, the company plans to return 70-75% of its free cash flow to investors.

The company raised its dividend by 250% to $0.28 per share per quarter. This translates to a return of 0.7%. It also launched a $15 billion buyback program, worth more than 8% of its market value.

While this dividend yield is disappointing, the company is on track to generate $7.1 billion in free cash flow in 2026 (16% CAGR), which translates to a free cash flow yield of 4%, indicating a Plenty of room for earnings growth. (And buy back).

It also has a very healthy balance sheet with a leverage ratio of less than 1x. In other words, I think it’s fair to call GE a dividend growth stock.

Returning to the growth drivers, the Commercial Engines and Services (“CES”) sector, which is worth $24 billion and 70% of which is services, saw orders increase by 34% in the first quarter.

This growth was driven by strong demand for LEAP engines and parts across multiple platforms, with major wins including more than 300 LEAP-1B engines for Akasa Air and large widebody engine contracts with Thai Airways, Ethiopian Airlines and LATAM Group.

Meanwhile, the defense sector saw orders rise 34%, resulting in a 1.1x book-to-invoice ratio ($1.10 in new orders for every $1.00 in finished work). Growth was so strong that the company raised its guidance, forecasting at least $6.2 billion in full-year revenue — up from $6.0 billion. It is also expected to convert more than 100% of its net income into free cash flow, which is a sign of quality earnings.

So, what does this mean for shareholders?

evaluation

If I said GE Aerospace was cheap, I’d be lying. And after its impressive height, it is far from cheap. Anyway, I’m comfortably sticking to mine He buys evaluation.

Using the FactSet data in the chart below, GE is trading at a blended P/E ratio of 54.0x, which seems like a high number.

The good news is that earnings per share this year are expected to grow by 80%, likely followed by growth of 28% and 18% in 2025 and 2026, respectively.

As such, I think it’s fair to apply a five-year P/E ratio of 35.7 times. This implies an annualized return of 12.5%, giving GE a fair share price of $217, 33% above the current price.

I’m currently looking for an entry that involves managing my cash reserves, having been an aggressive buyer of a few companies this year, including Texas Pacific Land Corporation (TPL) and Old Dominion Freight Line, Inc. (ODFL), which represents a large portion of my money.

In other words, I don’t have a lot of money, as I didn’t expect to start two new jobs (yet) this year.

However, while the 22% flight-mode expansion may go a bit far, I have no doubt that GE is one of the best wide-moat stocks on the market — even at these prices.

Away

Looking at my investment choices, I’m mostly satisfied, but missing out on General Electric (now known as GE Aerospace) still hurts.

Since coverage was restarted in June 2023, GE is up 92%.

The company’s strong moat, driven by extensive R&D operations, partnerships and dominance in both the commercial and defense sectors, makes it an industry leader. Financially, GE is also thriving, with impressive growth in orders, revenues and free cash flow.

Although the stock isn’t cheap after its rally, its future growth potential keeps it on my buy list. Despite my extensive experience in aviation, I am determined to add GE to my portfolio as soon as possible.

Pros and Cons

Positives:

• Wide trench: GE Aerospace has an impressive moat, driven by significant government-backed R&D investments, significant market share, and strong customer and supplier relationships.
• Economic power: The company demonstrated strong financial performance with double-digit growth in orders, revenue and free cash flow.
• Earnings growth: The recent dividend increase and $15 billion buyback program are a good start to what will likely be a long period of high dividend growth.
• Market dominance: General Electric operates a large portion of global commercial flights, with a huge market share in both narrow-body and wide-body engines.
• Growth potential: GE has a positive growth outlook for earnings per share and free cash flow, with a fair share price target of 33% above the current price.

cons:

• evaluation: After its impressive rally, GE isn’t cheap. The current P/E ratio is high, which may limit the upside in the short term. It also leaves GE little room for error when it comes to reporting future financial results.
• Market fluctuations: The aviation industry can be volatile, with external factors such as geopolitical tensions and economic downturn affecting its performance.