GE GE Aerospace

By Jon Sindreu 

A "V-shaped" recovery is looking even more unlikely for aircraft-engine makers than for the global economy.

Last week, General Electric and Raytheon Technologies reported steep losses in their aerospace divisions. In normal times these make up roughly 70% and 80% of the conglomerates' operating earnings, respectively.

Airlines have been hit harder by Covid-19 than plane makers Boeing and Airbus, which have more robust balance sheets. But parts manufacturers that rely on the maintenance, repair and overhaul of aircraft have historically had even more volatile revenues than carriers.

Key among these suppliers are makers of engines -- the most technologically complex part of the aircraft. They have embraced this so-called aftermarket, often selling their products at a loss and slowly clawing back the money by servicing them. In the second quarter, aftermarket revenues for General Electric Aviation and Raytheon's Pratt & Whitney, the two top American jet-engine makers, dropped 67% and 51% year over year, respectively.

These figures, though horrid, came in better than expected, given that air traffic globally was down 80% from a year ago in June, according to the International Air Transport Association. Raytheon Chief Executive Greg Hayes told analysts that he believed the second quarter would be the trough.

With a lag of roughly three months, aftermarket business has usually rebounded strongly after precipitous falls, leading to bouts of outperformance for the shares of engine manufacturers over those of Boeing and Airbus.

But this time could be different.

In this highly unusual crisis, airlines have been forced to keep some routes active in exchange for government aid. The number of planes in the sky, which is what matters for the maintenance business, has fallen less than passenger numbers.

Another factor has been the growth of "power by the hour" contracts, which spread maintenance payments depending on engine use. Traditional contracts involving lump sums incentivized carriers to stop going to the shop during downturns, only to return all at once as the outlook improved. Yet lower volatility will also mean less upside later on.

Above all, investors may still be underestimating the sheer severity of the current downturn and its impact on the global fleet.

The retirement of older models like the era-defining Boeing 747 or many jets of the Airbus A330 family, as happened after previous aviation downturns, wouldn't be a surprise. This puts Britain's engine specialist Rolls-Royce, which is focused on large planes, at a particular disadvantage.

Yet younger, more popular models might not escape unscathed. Even some previous-generation Airbus A320s and Boeing 737s serviced by both GE and Pratt, which are the backbone of the global narrow-body fleet, could stay parked. This would further reduce the potential installed base of jets in need of repairs, and create an oversupply of engines that, while older, still have "green time" left in them -- meaning they can be swapped in to replace any that would otherwise need maintenance.

Robert Spingarn, Credit Suisse's aerospace analyst, estimates that, while the total active plane fleet will decline 37% in 2020, jets out of warranty will fall by 58%. Looking at the engines that power the older generation of A320 and 737 aircraft, about 70% of the fleet that was flying at the end of 2019 could be brought back using only engines that won't need overhauls until 2023 or later.

"The depression is so deep that if we have a more permanent shrinkage of the fleet, maybe that wave of overhauls doesn't eventually come," he said.

Rather than expecting the traditional aftermarket rebound, investors should brace for potential mergers, and even a rethinking of the industry business model. For engine makers, this is no ordinary downturn.

Write to Jon Sindreu at jon.sindreu@wsj.com

(END) Dow Jones Newswires

August 03, 2020 08:07 ET (12:07 GMT)

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