Aerospace equipment suppliers such as GE Aerospace (G.E. -2.09%) are not always the easiest to assess. This is clear from GE’s recent results and the resulting stock sell-off. While there were some negatives, the market may have missed a significant upside in management’s comments. Here it is, and here’s why it’s important.

How GE Aerospace Makes Money

The good news comes from an extension of the time GE expects a peak in “store visits” on its legacy aircraft engines installed on planes already in flight. To put this into simple terms and explain why it’s so important, it’s essential to understand how GE makes money.

GE management has expressed dissatisfaction with the business model of selling aircraft engines. These engines are typically sold at a loss, and the real money is made in the aftermarket, which can extend over 40 years of an engine’s lifespan. After-sales service revenue is primarily generated through workshop visits, during which engines are brought in for a complete overhaul and maintenance.

However, it takes many flight hours, and usually years, before the engines are shop inspected. As such, when GE introduces a new engine, it will continue to rely on aftermarket revenue from existing engines on older aircraft for many years, until aftermarket revenue from new engines are starting to come into play.

The LEAP replaces the CFM56

The all-new narrow-body engine from GE’s joint venture with SaffronCFM International, is the LEAP, responsible for supplying the Airbus A320 neo family, the Boeing 737 MAX and COMAC C919 aircraft. Since its first delivery in 2016, the LEAP engine has powered a new generation of aircraft and will be GE’s primary source of revenue in the future. However, CFM’s CFM56 powers the legacy Airbus A320 family and the Boeing 737 aircraft. GE’s narrow-body aftermarket service revenue will migrate, over time, from the CFM56 engine to the LEAP.

This was demonstrated during the investor day presentation in March, when management predicted that peak store visits for the CFM56 would be in 2025, followed by a sequential decline in 2026 and 2027.

Image source: GE Aerospace presentations.

While CFM56 shop visits are expected to peak, shop visits for LEAP engines will increase as the engines operate, leading to LEAP service revenues gradually replacing CFM56 service revenues. The following graphic from the March presentation illustrates this.

Image source: GE Aerospace presentations.

Why the market has sold off GE Aerospace stock recently

It’s no secret that a mix of persistent supply chain issues in the aerospace industry and fewer aircraft deliveries than expected at Boeing and Airbus have led to a slowdown in LEAP engine deliveries. While this is “good” news for GE’s earnings in the short term, as engines tend to be loss-making, this is not what GE wants as it pushes earnings and cash flow after-sales services on the LEAP.

GE began the year expecting a 20% to 25% increase in LEAP deliveries, but has lowered its expectations each quarter, with the latest update forecasting a 10% decline in 2024. That’s likely the reason why the title was sold recently.

Data source: GE Aerospace presentations. Table by author.

What the market missed

Although LEAP engine delivery delays are negative, they are not a consequence of final demand issues. Airlines continue to expand their routes and flight times. So older planes are running more, which means aircraft engines, including the CFM56, are also running more.

Therefore, Rahul Ghai, CFO of GE Aerospace, recently updated investors on the evolution of shop visits for CFM56 engines. Instead of a peak in visits in 2025 and then a sequential decline, Ghai now expects a “peak in store visits in 2025, but now to stay at this level until 2027, then start to decline again from that point on, again, at a gradual pace.” ”

The extension of peak workshop attendance on the CFM56 means that the engine will contribute more to service revenue than was implied during the investor day presentation (see charts above). Additionally, management estimates that the second and third shop visits generate 30% and 25% of an engine’s life cycle revenue, compared to 20% for the first shop visit. Therefore, GE has a growth opportunity if an extension of peak shop visits on the CFM56 leads to more second and third shop visits before an engine is taken out of service.

Image source: Getty Images.

What this means for investors

While the delay in LEAP engine deliveries is disappointing, continued growth in flight departures means increased CFM56 service revenue. That’s a positive from recent results, and with commercial engine service orders growing 33% year-over-year through the first nine months, GE has plenty of growth prospects.