TIP854: GE Aerospace: Chris Hohn’s Biggest Bet w/ Daniel Mahncke & Shawn O'Malley

Shawn O'Malley · The Investor's Podcast NetworkBearish

Jeff Immelt's GE was a case study in value destruction: bad acquisitions and buybacks at high prices.

Under Jeff Immelt, GE bought Alstom's power business for about $10B in 2015, just before the gas turbine market collapsed. It spent $93B on buybacks, most of it at prices above $30 per share, while the stock later fell below $7. In 2018 GE was removed from the Dow after more than a century of membership. Shawn calls the tenure one of the best case studies of how not to run a business. He also says that results matter and Immelt did not deliver for much of his tenure.

“Emolt made some pretty massive mistakes during his tenure, I think it's fair to say. And it might be really one of the best case studies for how not to run a business.”at 22:10

Shawn O'Malley · The Investor's Podcast NetworkBullish

Larry Culp's 2021 three-way split of GE may be one of the best CEO decisions ever.

When GE was split into three parts in 2021, Larry Culp's first day as CEO had a market value of about $96B. The three companies that resulted from the split, which include GE Aerospace, are now worth over $600B combined, even after GE Aerospace fell about 20% from its summer high. That is more than six times the money in eight years, roughly 26% a year compounding, versus about 13% a year for the S&P 500 over the same period. GE Aerospace has more than doubled since the energy business spin-off in April 2024.

“when we look at the history of maybe best CEO decisions ever, this actually might very well be up there.”at 25:19

Daniel Mahncke · The Investor's Podcast NetworkBullish

GE Aerospace has better economics than HEICO and TransDigm because it sits higher in the aviation value chain.

Economics improve the higher up the aviation value chain a company sits: airlines have the worst economics, and Boeing and Airbus, despite a duopoly, have not produced great margins and make mediocre capital-intensive investments. GE sells new engines at roughly breakeven or a loss, then earns on the aftermarket, which is the most profitable part of aerospace. Services are more than 70% of commercial engine revenue. GE's own math is that each engine returns about 3.5 times its original revenue in services over its life, and the commercial engine segment earns a 27% margin. GE's return on invested capital is close to 40%. Third-party data sites understate it because they include the insurance business. Shawn adds that GE is about $40B in revenue against TransDigm's $9B and HEICO's $4.5B, with similar profitability.

“At the risk of spoiling, I would say it's an even better business than the two of them. So HEICO and TransDigm. And it basically feels like the higher up the value chain you go, the better the economics actually become.”at 26:41

Daniel Mahncke · The Investor's Podcast NetworkBullish

GE Aerospace's installed base and certification barriers make its jet-engine position very hard to disrupt.

Engines take roughly a decade and several billion dollars to develop, and the FAA and EASA require thousands of test cycles before certification. Once an engine is certified for an aircraft type it is effectively locked in, so competitors struggle to enter. GE holds about 40% of the global engine maintenance, repair and overhaul market, which Daniel calls technically an oligopoly and possibly a monopoly given how contracts are structured. Its installed base of about 50,000 commercial and 30,000 military engines is under long contracts. Selling an engine also requires a global repair network, spare parts, spare engines and trained technicians. Leasing companies, which own about half of commercial aircraft, usually insist on original parts to protect resale value, which reinforces GE's position. Shawn adds that once an OEM picks a GE engine, it signs a multi-decade service commitment.

“So that is very hard to disrupt because the contracts are just going for such a long time. And for GE, for example, we're talking about 50,000 commercial engines and 30 k military engines in service around the world.”at 29:54

Shawn O'Malley · The Investor's Podcast NetworkBullish

GE's LEAP engine dominates narrowbody share, and its deliveries are growing fast, showing GE's market power.

The LEAP is the most important engine right now, on the Boeing 737 MAX and the Airbus A320neo family, and it holds roughly 55 to 60% of that market against Pratt & Whitney's geared turbofan. It is also on a Chinese plane, which Shawn sees as a testament to GE's market power despite China's manufacturing and geopolitical sensitivities. CFM delivered about 1,800 LEAPs last year, up 28%, and more than 1,000 in the first half of this year, up 40%. Shawn treats this volume growth as evidence of the franchise's strength.

“CFM delivered 1,800 leaps last year, up 28% and more than 1,000 in the first half of this year, which is up 40%.”at 37:21

Shawn O'Malley · The Investor's Podcast NetworkBullish

GE's military business is highly protected and could warrant a higher multiple than commercial.

GE's defense business earns lower margins than commercial, but it is highly protected. Almost no scenario exists in which GE loses that business or earns a margin below a low double-digit level. Because the earnings are that protected, the defense business could warrant a higher multiple, and might even be worth more than the commercial side. Daniel Mahncke agreed that this was fair.

“there is really almost no world imaginable in which GE would lose that business or generate a margin below at least a low double digit margin. And so my opinion that does actually warrant a higher multiple”at 47:54

Daniel Mahncke · The Investor's Podcast NetworkBullish

GE's roughly $210B backlog, mostly high-margin services, gives long-dated revenue visibility.

GE's backlog of contracted but unrecognized revenue is about $210B, of which almost $180B is services (spare parts and maintenance), the high-margin part of the business, about 85% of the backlog. That is more than four years of total revenue. Service contracts run 10 to 20 years and are on average only a fifth of the way through, so the backlog converts slowly and gives stable visibility. Service revenue is currently about $25B a year.

“is the massive backlog. So the revenue that's already under contract but not yet realized is about $210,000,000,000. And of that, almost $180,000,000,000 is services.”at 49:31

Shawn O'Malley · The Investor's Podcast NetworkBullish

Aging fleet and parts shortages keep GE's engine shop-visit demand ahead of its supply.

The commercial fleet is aging: average age is above 15 years, and IATA estimates the industry is about 5,500 aircraft short of the pre-pandemic path because of production delays. Engines have regulator-enforced service limits and degrade with age, so older engines need more frequent and more costly shop visits. Planes that would have been retired keep flying and need maintenance. The LEAP engine is only now reaching its first wave of shop visits, and GE guides LEAP shop visits to grow about 25% a year through 2030, with second visits more expensive around 2028 to 2029. Parts GE owes customers rose 20% in Q2, and Culp called it a supply-side challenge.

“So when we look at the LEAP engine we talked about earlier, it's just now reaching its first wave of shop visits. And so GE guides LEAP shop visits to grow about 25% a year through 2030”at 51:20

Daniel Mahncke · The Investor's Podcast NetworkBearish

LEAP engine's hotter-running design wears parts faster, a real margin problem for GE's maintenance.

The LEAP engine burns about 15% less fuel than its predecessor, but it does so by running hotter, which wears parts out faster, especially in hot, dusty regions such as the Middle East or India. Some engines there needed a first overhaul after about a year and a half instead of five years. Under flight-hour service contracts, GE bears the cost of maintenance overruns, so this shifts cost onto GE. Shawn O'Malley noted that the new-engine maintenance business lost money for years and only broke even in 2024.

“And it's actually quite of a problem with the LEAP engine right now because it's known to be more efficient and burn about 15% less fuel than its predecessor. However, it does that by basically running hotter, which means... parts wear out faster”at 54:42

Daniel Mahncke · The Investor's Podcast NetworkBullish

GE's CEO Larry Culp has a strong track record from Danaher and deserves credit for GE's turnaround.

Larry Culp spent his career before GE at Danaher, joining in 1990 and becoming CEO in 2001. Under him, Danaher's revenue and market value both rose about fivefold. He brought the Danaher Business System, a lean manufacturing and continuous improvement approach, to GE. Daniel calls him somewhat of a genius for what he did at GE. A controversial point was his pay: his 2018 contract was worth up to $300M, and about 60% of shareholders voted against it in 2021.

“he's somewhat of a genius for what he did to GE. He spent basically his whole career before GE at Danaher... under him, Danaher's revenue and market value both went up fivefold.”at 55:55

Daniel Mahncke · The Investor's Podcast NetworkBearish

GE's buybacks at about 40x free cash flow give shareholders only a 2.5% buyback yield.

GE has spent nearly all its free cash flow, about $8B a year, on share buybacks. It trades at about 40 times price to free cash flow, so the company is buying back stock at hefty valuations, and the resulting buyback yield to shareholders is only 2.5%. Daniel compares this to Immelt's buybacks of about $93B at high valuations, and says this is the main capital allocation criticism.

“I think that's different, but that was certainly not the case here. So one thing that I actually do criticize a bit is the capital allocation. In the last few years, GE spent pretty much all of its free cash flow on share buybacks”at 57:57

Shawn O'Malley · The Investor's Podcast NetworkBullish

GE's debt paydown before buybacks was a sound capital allocation decision that lowered risk.

About a decade ago GE carried more than $100B of long-term debt. It cut the dividend to repay that debt, and it started buybacks only after it had drastically reduced debt, which is now about $17B. Given the company's large cash flows, that debt is manageable. This sequencing maximises long-term value and removes baked-in risk.

“What I would give them credit for is that they only started the buybacks when they'd already drastically reduced long term debt.”at 58:37

Daniel Mahncke · The Investor's Podcast NetworkUncertain

GE's Consolidated Precision Products deal makes strategic sense for supply control despite a high price.

GE agreed to buy Consolidated Precision Products (CCP) for about $11.75B, about 26 times expected 2027 EBITDA, with about $7B paid in cash and new debt. CCP already supplies about a quarter of GE's airfoils, which are blades and vanes, and this is one of GE's biggest bottlenecks. Bringing it in house gives GE more control over supply. GE also cites about $200M of cost and productivity synergies. The strategic logic is clear, but the price is high.

“That's certainly how I would think about it. So CPP already supplies about a quarter of GE's air foil, so, you know, the blades and the [vanes] inside the engine.”at 1:01:12

Daniel Mahncke · The Investor's Podcast NetworkUncertain

Aviation downturns hit GE hard: profits fell 82% in 2020 and took until 2024 to recover.

GE's business has many physical assets and high operating leverage, which cuts both ways. In 2020, GE Aviation's revenue fell 33% and profits fell 82% in one year, and it took until 2024 to get back to 2019 levels. A macro shock that reduces flying could quickly erode GE's current profits. Services are more resilient than new engines, because airlines defer shop visits and run engines on green time. GE is also more concentrated than TransDigm, with one large product line that must win each new engine generation.

“So for example, in 2020, GE Aviation's revenue fell 33%, and then profits fell by 82 in just a single year. And then it took until 2024 to get back to 2019 levels.”at 1:02:38

Shawn O'Malley · The Investor's Podcast NetworkBearish

Regulators are pushing to allow cheaper certified parts, eroding GE's aftermarket lock-in.

Airlines are pushing regulators to allow cheaper certified parts in place of original parts, which squeezes GE's aftermarket pricing. GE can no longer void the warranty when airlines use cheaper certified parts. The EU forced Pratt & Whitney Canada, a GE competitor, to drop contract terms that block used parts. Shawn compares this to Apple restricting third-party repairs, and says things are slowly changing, though GE's parts complexity still protects it from direct competition.

“So as you mentioned, there is a push in that direction already... And so GE can no longer waive the warranty when airlines use cheaper but certified parts... So things are slowly changing.”at 1:04:19

Daniel Mahncke · The Investor's Podcast NetworkBullish

GE's earnings per share should grow about 16% a year for four to five years.

Daniel's model has services revenue growing 21% this year, in line with guidance, then slowing to 9 to 10% a year through 2030. New engines grow 20% this year, then about 7%. Defense grows about 10% this year, then about half that. Total revenue reaches about $70B by 2030, a roughly 10% compound rate. Commercial margins rise from 26% to 29% by 2030 as the LEAP drag normalises, which management guides to around 2028. Buybacks shrink the share count by 1 to 2% a year, and the dividend may grow in the mid-teens. Together this supports about 16% EPS growth.

“thanks to GE's buybacks, which I'm not a huge fan of, but they're still adding to your return... I could definitely see earnings per share growing at about 16% a year for the next four to five years.”at 1:08:02

Shawn O'Malley · The Investor's Podcast NetworkBullish

GE Aerospace's advantaged business warrants a 30x-plus exit multiple, so it is a fair price, not expensive.

GE Aerospace is well insulated and competitively advantaged. Ferrari and Hermes have traded at well above 30x and even 40x earnings on average, so a 30x exit multiple for GE is not unreasonable and may prove conservative. The stock is not clearly on sale, so at best the investor pays a fair price for a very good business, and one can do much worse as an investor.

“I don't think it's completely unreasonable at all to think that a business that's as well insulated and competitively as advantaged as GE would warrant something like a 30 times exit multiple or more.”at 1:12:10

Shawn O'Malley · The Investor's Podcast NetworkNeutral

A 30x exit multiple is reasonable for GE; the stock looks like a fair price for a great business.

Hermes and Ferrari have traded at well above 30 times, even around 40 times, earnings on average. GE is at least as insulated as those businesses, through contractual and regulatory guarantees and inelastic demand for flying, so a 30x or higher exit multiple is reasonable and may even be conservative. The stock is not on sale, though, so at best the investor pays a fair price for a very good business.

“I don't think it's completely unreasonable at all to think that a business that's as well insulated and competitively as advantaged as GE would warrant something like a 30 times exit multiple or more.”at 1:12:10

Daniel Mahncke · The Investor's Podcast NetworkBearish

At 40x earnings, GE returns only high single digits even if the multiple falls to 30x.

Valuation is the key driver of the model, which is mainly the exit multiple. Daniel's model says the stock is only worth buying in the 35 to 40 times earnings range to get a good return. Even at a 30x exit multiple, his model suggests high single-digit returns, because the stock currently trades at 40x. Multiple compression can outweigh strong earnings growth, as with software stocks in the SaaS sell-off.

“even at your 30x multiple, the return that, for example, in my model would be suggested, it's still in the high single digits, if even, just because you're currently trading at 40x.”at 1:12:51

Shawn O'Malley · The Investor's Podcast NetworkBearish

TransDigm's pricing power over the government is a regulatory risk to its moat.

TransDigm generates much of its shareholder value by raising prices on sole-source aftermarket parts, which Shawn calls price gouging. It is protected mainly by a regulatory moat, so it is exposed to regulatory action while it charges the government and taxpayers high prices. Shawn says he would be constantly concerned about this even though nothing significant has happened yet. He compares it to FICO, where pricing power turned from an advantage into a risk.

“I would be constantly concerned that something happens to TransDigm on the regulatory front. And ultimately, they are protected primarily by a regulatory moat while using that position to gouge the government”at 47:16

Shawn O'Malley · The Investor's Podcast Network

Airlines are revolutionary but have created little shareholder value; engine and parts makers earn the profits.

Shawn compares airlines like United and Delta, which have long histories and are essential to society, with aerospace suppliers such as GE, TransDigm and HEICO, which earn highly profitable returns. Airlines have created little shareholder value over their histories. The profits go to the parts providers and engine builders that supply inputs to flying. Shawn suggests the same value-chain logic may be a useful parallel for AI, where the companies enabling the technology may capture more value than its users.

“you know, the airlines taking folks from point A to point B who actually make the most money. In this case, you know, it's the parts providers, the builder of engines,”at 9:21

Daniel Mahncke · The Investor's Podcast Network

Rising global air travel is a massive long-term tailwind, as people spend more on trips than luxury goods.

He likes the long-term tailwind of more people traveling by air and expects it to be a massive driver over the next twenty to thirty years. He ties this to a shift in consumer spending, with many people spending more time and money on visiting places such as Hawaii and other parts of the world rather than chasing luxury goods. He had made the same argument in the Transom and LVMH episodes.

“I think that will be a trend that over the next twenty, thirty years' time will be a massive tailwind.”at 1:13:49