The sell-off in the stock post-earnings looks overdone.
The reaction to GE Aerospace‘s (GE -0.36%) latest earnings report might make it to an investing trivia game show one day. When did a company last decline 9% on the day of results that included management raising its full-year operating profit, earnings per share (EPS), and free cash flow (FCF) guidance? Here’s what happened and how to think about the stock.
Unpacking GE Aerospace’s latest news
The table below shows how GE raised guidance across the board, yet the market sold off the stock heavily on the release day. The market is worried about something other than the headline numbers, and on closer inspection, it’s clear two issues with GE’s current operations are causing concern.
|
Full-Year 2024 Guidance Metrics |
July |
Current |
|---|---|---|
|
Adjusted revenue growth |
High single digits |
High single digits |
|
Operating profit |
$6.5 billion to $6.8 billion |
$6.7 billion to $6.9 billion |
|
Adjusted EPS |
$3.95-$4.20 |
$4.20-$4.35 |
|
Free cash flow |
$5.3 billion to $5.6 billion |
$5.6 billion to $5.8 billion |
Data source: GE Aerospace presentations.
LEAP deliveries
GE Aerospace operates in two segments: Commercial Engines & Services (CES) and Defense & Propulsion Technologies (DPT). CES is, by some distance, the more important of the two segments. Its engines dominate the commercial aviation market, with positions on both narrowbody workhorses of the skies (the Boeing 737 MAX and the Airbus A320neo) and the widebody Boeing 787, 777X, and Airbus A330.
CES is also the star performer this year, and once again, the reason for the guidance hike is that CES’ operating profit guidance was raised from $6.6 billion to $6.8 billion from $6.3 billion to $6.5 billion previously.
Image source: Getty Images.
However, investors are concerned that the ongoing supply chain issues negatively impact CES’ ability to deliver airplane engines, notably the CFM International (a joint venture between GE and Safran) LEAP engine (the sole option on the Boeing 737 MAX and one of two on the Airbus A320neo).
The table below shows the significant reduction in delivery growth expectations due to supply chain issues compounded by the Boeing strike. While fewer deliveries aren’t a negative in terms of near-term earnings because engines tend to be loss-making, they will negatively impact the long-term trajectory of long-term aftermarket revenue on the LEAP engines. CES primarily makes its money on commercial engine aftermarket parts and service.
As such, the market is probably concerned that the ongoing LEAP delivery issues could eventually catch up with GE, even if near-term CES profitability is excellent.
|
GE Aerospace Full-Year Guidance |
At January |
At April |
At July |
Current |
|---|---|---|---|---|
|
LEAP deliveries growth |
20%-25% |
10%-15% |
0%-5% |
Down 10% |
Data source: GE Aerospace presentations.
Defense & Propulsion Technologies
The midpoint of CES’ operating profit guidance is $6.7 billion, while the DPT operating profit guidance range has remained at $1 billion to $1.3 billion through the year. However, management said it would be at the lower end of the range in the latest update. CFO Rahul Ghai discussed the matter on the earnings call, highlighting an increase in research and development investment to support next-generation programs and “some pressure” in propulsion and additive technologies.
Image source: Getty Images.
It’s disappointing news because it speaks to a general trend in the defense industry: Defense technology’s increasing complexity and sophistication put cost pressure on the sector while governments are getting better at utilizing their powerful bargaining position.
Did the market overreact?
The sell-off is an overreaction if you thought the stock was a good value before the earnings report. While the defense news is disappointing, the DPT segment isn’t GE’s key earnings driver.
The issues with LEAP deliveries are concerning, but end demand remains strong, as does demand for Boeing and Airbus airplanes. Both manufacturers have multiyear backlogs in place and continue to win new orders. As such, the LEAP engine deliveries are likely to be pushed out; it’s not a cancellation — management affirmed it expects LEAP engine deliveries to grow in 2025.
Meanwhile, the negative news on LEAP deliveries overshadowed the whopping 29% increase in CES orders in the quarter, leading to a 33% increase in CES orders on a year-to-date basis. In total, GE Aerospace’s orders are up 26% on a year-to-date basis, and with commercial aerospace services continuing to outpace expectations, the sell-off looks unjustified.
Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.