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Summary
Aviation has a strong catalyst with its LEAP engine and the segment's financial
performance has been great in recent years.
The segment will continue to add value to investors in the years to come absent any
unforeseeable circumstances.
General Electric (GE) owns a powerhouse. Though news related to the company has
been bearish for investors in recent months, some parts of the enterprise are alive and
well. At its core, the firm is an aggregation of smaller (but still very large) businesses
across a wide spectrum of industries, but the crown jewel is its Aviation segment. With
strong financial performance and a positive reception of its newest product, the value-
creating potential for investors here is tremendous.
The best thing about this (and the segment as a whole) is that demand growth for these
goods and services is likely to increase. In 2017, there were 37.5 million commercial
aircraft departures, up from 35.8 million a year earlier. By 2020, that number should
approach 40 million, and management estimates that General Electric and its joint
ventures will collectively account for the equipment on about two-thirds of departures.
During this timeframe, the number of worldwide shop visits for existing aircraft will also
grow, rising 6% CAGR to grow from 4,500 in 2016 to 5,600 in 2020.
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Leading the way on the commercial front, Aviation has also unveiled the new LEAP
engine. With each unit 500 pounds lighter than those preceding it, and fuel efficiency that
will reduce consumption by an estimated 15%, LEAP has already seen in excess of 14
thousand orders booked. Of these, between 450 and 500 were delivered in 2017, but as
the image above shows, that number should increase materially this year. By 2020, the
firm will be able to deliver in excess of 2,200 units per year.
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Of course, General Electric's Aviation segment doesn't derive revenue from the
commercial space only. In 2017, management said revenue from the military would
amount to $3.8 billion. By 2020, this number is expected to grow to $4.8 billion and, as
global military spending continues to increase in the years ahead, a rise to $8.7 billion is a
realistic expectation.
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*Created by Author
Even as sales have increased, orders have been greater than revenue has been. In sum,
new orders put onto the books over the relevant five-year period have come out to $134.8
billion, which has increased backlog for the segment from $102.4 billion to $154.8 billion.
At the end of the third quarter of General Electric's 2017 fiscal year, backlog for Aviation
ballooned to $160.7 billion. That's 3.1% above where it was the same time a year earlier.
Due to this increase in backlog, revenue growth in the years to come should be strong. So
far, management has only provided a glimpse of one full year of revenue growth. In 2018,
organic sales growth for the segment should total between 7% and 10%. That significantly
outpaces the 2% to 4% increase that had been forecasted for 2017.
The importance of Aviation cannot be summed up in sales growth alone, though. More
important than that is the segment's profitability. In the chart below, you can see the
segment profit that has been generated by Aviation over the past five years, as well as for
the first three quarters of 2016 compared to the first three quarters of 2017. Between 2012
and 2016, segment profit soared from $3.75 billion to $6.12 billion. Data for 2017 so far
has the results being even better, with profits growing from $4.37 billion in the first three
quarters of 2016 to $4.86 billion the same time last year.
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*Created by Author
From a margin perspective, performance has been robust. In the chart below, you can see
that the segment profit margin has grown every single year since at least 2012, rising from
18.7% to 23.3% in 2016. In 2017, margin so far has been 24.1% compared to the 22.9%
seen during the same three quarters of 2016. In its investor presentation, management
highlighted that, in 2018, the cost of producing the firm's LEAP engines should fall by
around 23% compared to 2017, so it's possible, even probable, that continued margin
expansion is on the table for the next year or so.
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*Created by Author
This growth in profitability has also impacted Aviation's return on assets. Even as General
Electric's assets under this segment have grown from $25.15 billion in 2012 to $38.90
billion in 2016, the return on assets has increased modestly from 14.9% to 15.7%. In such
a capital-intensive enterprise as this, any sort of improvement on the return on assets front
should be celebrated and margins of this magnitude suggest that management would be
wise to continue investing into this space, even if they must use debt to do so.
*Created by Author
Takeaway
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any
positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving
compensation for it (other than from Seeking Alpha). I have no business relationship with
any company whose stock is mentioned in this article.
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