Shares in General Electric, now GE Aerospace(NYSE: GE), rose by 11.9% in March, according to data provided by S&P Global Market Intelligence. The move occurred in the run-up to the successful spinoff of GE Vernova (NYSE: GEV) (listed as a separate company on April 2.) and bodes well for the new aerospace and defense company.
GE Vernova
For reference, GE Vernova combines GE's power business (primarily gas turbines and services), its renewable energy (wind turbines), and its electrification businesses. It's an exciting company because it has an opportunity to significantly improve profitability in the coming years by working through a less profitable backlog in offshore wind and growing margins in offshore wind, electrification, and power services.
The spinoff has begun well, and GE Vernova's current market cap of $38 billion is more than many had anticipated.
GE Aerospace
The market also warmed to the separation of GE Aerospace, and its potential for multiple valuation has increased now that it no longer has GE Vernova attached. Investors tend to accord aerospace stocks high valuation multiples because of their potential for long-term growth.
That's an especially relevant point with GE Aerospace, whose airplane engines are loss-making (which is known as "negative engine margin") but generate decades of lucrative aftermarket revenue as they are serviced. Because of this, engines go through margin and profit cycles.
Why investors are paying a premium for GE Aerospace
GE's joint venture with Safran, CFM International, delivered 1,136 LEAP engines (used on the Airbus A320neo family and the Boeing 737 MAX) in 2022 and then 38% more to 1,570 in 2023, and management plans to deliver 20%-25% more in 2024.
Unfortunately, this aggressive increase in engine production is holding back margin growth, and management believes its profit margin could be flat in 2023. Still, every engine delivered now means more service revenue in a few years. That's why the market is willing to pay a premium valuation for GE Aerospace now, especially because it's an independent company.
Image source: Getty Images.
Where next?
The midpoint of management's guidance for 2024 calls for operating profit to increase by 11.6% to $6.25 billion from $5.6 billion in 2023. Furthermore, management expects an operating profit of $7.1 billion to $7.5 billion in 2025, the midpoint of which implies a 14.1% compound annual growth rate from 2023-2025.Beyond that, LEAP engine services revenue will kick in. The stock is primed for excellent long-term growth.
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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.
