BREAKINGVIEWS-Aerospace’s epic backlog upends business-as-usual

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Oliver Taslic

FARNBOROUGH, England, July 23 (Reuters Breakingviews) - Big corporate beasts in the civil aerospace market tend to be divisible into two main species. “Original equipment” (OE) players like $190 billion Airbus AIR.PA and $160 billion Boeing BA.N specialise in providing new kit – think a carrier like easyJet EZJ.L or United Airlines UAL.O taking delivery of a box-fresh plane. Their engine-making counterparts in the “aftermarket”, like $160 billion Safran SAF.PA and $350 billion GE Aerospace GE.N, predominantly make money servicing planes that are already flying. What’s curious is that, against the backdrop of this week’s biennial Farnborough International Airshow, both groups are doing well at the same time – and the Iran war has done surprisingly little to blow them off course.

Theoretically, engine companies and plane makers should be on something of a seesaw. If Airbus and Boeing are flying high delivering plenty of new jets, it may not be ideal for engine companies – every new plane delivery gives airlines an opportunity to retire an older one that may have otherwise needed pricey maintenance. Though everything from an aircraft’s landing gear to airframe will need some sort of maintenance over time, the most lucrative part of the aftermarket is engines, whose intense heat and rotation speeds mean they need extensive upkeep. A joint study from the International Air Transport Association (IATA) and Oliver Wyman estimated that engines accounted for 52% of the $120 billion in aerospace maintenance, repair and overhaul (MRO) spend last year.

Conversely, if engine companies are doing well, they’re typically servicing lots of older, less fuel-efficient planes, since providing spare parts and the like for elderly engines carries much higher margins than delivering new ones. The low-margin airline sector would ideally prefer to avoid flying maintenance-hungry gas-guzzlers. Hence if business at MRO mavens like GE, Safran or Rolls-Royce RR.L is booming, Airbus and Boeing are probably failing to deliver enough new planes to fulfil airline demand.

That’s certainly been the story in recent years. The pandemic dealt an almighty blow to the OE supply chain, with smaller suppliers coming under financial strain and many of the industry’s most senior and productive workers quitting during lockdowns. Shortages of seats and indeed engines made matters worse, while Boeing’s 2018 and 2019 MAX crashes and 2024 door plug blowout incident meant it had to revise its own delivery aspirations. The 1,600-plus aircraft Airbus and Boeing handed over in 2018 has yet to be topped, almost a decade on.

Yet the chat at Farnborough is that Airbus and Boeing are recovering their mojos. Airbus CEO Guillaume Faury told reporters on Tuesday that the supply chain was in a “much better place”, while the European plane maker also announced a €5 billion share buyback programme and said it was targeting 2029 adjusted operating profit between €12 billion and €13 billion – way above last year’s €7.1 billion. Boeing delivered 314 jets in the first half, its best haul since 2018, while a recent RBC survey pointed to increased confidence among suppliers in the U.S. group’s ability to churn out 50-plus of its workhorse 737 MAX jets per month.

Per the usual dynamic, you would therefore expect MRO players to be girding for a leaner period. The outbreak of the Iran war, which saw jet fuel prices double in a matter of weeks, should have made things worse. In a crisis, reducing maintenance or simply flying less – negatively affecting engines that charge on a “power-by-the-hour” basis – are familiar levers airlines can pull. Investors implicitly thought as much in March, when GE, Safran, Rolls-Royce and Germany’s MTU Aero Engines fell MTXGn.DE 16% on average, compared to a 5% fall in the S&P 500 Index .SPX.

Instead, the aftermarket is performing surprisingly well. GE, which along with its joint venture partner Safran produces the CFM56 and LEAP engines that power much of the world’s short-haul aircraft, last week raised its full-year operating profit forecast, with CEO Larry Culp saying the company’s overhaul shops were “wildly oversubscribed”. Jefferies analysts expect long-haul engine specialist Rolls-Royce to raise its own full-year financial guidance next week. Shares in GE, Rolls-Royce and Safran are now all up this year, with Rolls above its pre-war level.

What explains this unlikely double act? Simply put, Airbus and Boeing’s huge backlogs have changed the game. The duo’s troubles may have prevented them from delivering the required planes, but the demand has increased: IATA said last month the stock of aircraft waiting to get delivered had reached over 18,000. That’s equal to almost 60% of the active fleet – way above historical levels of between 30% and 40%. And the roughly 1,500 aircraft that analyst forecasts compiled by Visible Alpha suggest the duo will deliver this year still lags 2018 levels.

Such an enormous queue strains the logic of retiring older jets. That’s especially the case given that Iran hasn’t cratered global travel demand: total commercial flight activity was flat year-on-year as of end-June, according to RBC analysts, despite a 26% fall in the Middle East. Even if Airbus and Boeing pull off the Herculean feat of increasing production by hundreds of aircraft a year in short order, there’s still a big shortfall to make up for. In turn that implies large numbers of older planes continuing to operate, guaranteeing steady MRO revenues. One aerospace executive told Breakingviews on the sidelines of the airshow that normality may not return until the 2030s at the earliest.

Iran is far from resolved. If jet fuel prices stay elevated come the northern hemisphere’s winter – when much of European airlines’ pre-war fuel hedging also happens to roll off – under-pressure airlines might feel the need to retire a greater proportion of more inefficient older jets. Investors are hedging their bets a little: GE, Safran and Rolls’ valuation multiples have fallen slightly since the war, from an average of around 29 times forward operating profit to 25 times, according to LSEG data.

Even so, GE says retirements of the CFM56 remain low, while Jefferies analysts observe a similar theme for the rival V2500. That suggests the aftermarket will stay robust even as plane makers continue to regain their footing. Which in turn suggests the OE-MRO seesaw may stay at a mutually beneficial level for some time to come.

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(Editing by George Hay; Production by Streisand Neto)

((For previous columns by the author, Reuters customers can click on TASLIC/oliver.taslic@thomsonreuters.com))