GE Aerospace's Latest Wall Street Downgrade Isn't a Big Deal: Here's Why

GE Aerospace (GE 0.57%) stock has recently experienced a dip in value due to J.P. Morgan's decision to lower its estimate for second-quarter sales to $8.4 billion. This estimate is notably lower than the Wall Street analyst consensus of $8.85 billion, but is it a reason to sell the stock? Here's what you need to know before taking action.

The reason for the downgrade

J.P. Morgan's analyst is arguing that there's a mounting risk GE Aerospace could miss its delivery target for engines in 2024 amid ongoing supply chain pressures in the industry. Fewer engine deliveries mean less revenue, and the analyst believes the company could have a shortfall in the second quarter and possibly beyond.

If there is an engine delivery shortfall, it would be a negative, but there are several reasons investors shouldn't panic.

Near-term profitability

First, a slowdown in engine deliveries is a net positive for profit margins. Airplane engines are usually sold at breakeven or at a loss. The actual earnings and cash flow come from the multiple decades of aftermarket and service revenue generated on long-term contracts.

Indeed, the J.P. Morgan analyst maintained GE Aerospace's earnings and cash flow expectations for 2024. The analyst also kept the stock's $175 price target and overweight rating for reference.

This point is exemplified by the fact that GE Aerospace has already reduced its projections for engine deliveries this year. However, that cut led to an increase in margin and profit expectations, as outlined below. During the earnings call in April, chief financial officer Rahul Ghai put the profit-guidance hike down to "favorable revenue dynamics." As you can see below, GE Aerospace cut 2024 delivery expectations for the Leading Edge Aviation Propulsion (LEAP) engine used on the Boeing 737 MAX and the Airbus A320neo family of airplanes.

Data source: GE Aerospace presentations. 

Positive earnings drivers

Second, while a delay in LEAP engine deliveries is not what management wants, it could result in positives elsewhere. For example, new engines take years to start generating aftermarket revenue, so a delay in new engine deliveries could mean older engines, such as the CFM56 (used on the legacy Boeing 737 and Airbus A320 families), are used more -- meaning more aftermarket revenue from them.

CFM International, a 50/50 joint venture between GE Aerospace and Safran, manufactures the CFM56 and LEAP engines. On GE's investor day in March, management forecast that CFM56 shop visits (when engines are brought in for maintenance, repair, and overhaul) would peak in 2025.

Image source: Getty Images.

Fast-forward to April (when management cut its LEAP engine delivery forecast), and Vertical Research's Rob Stallard asked CEO Larry Culp whether the LEAP engine delays had "positive implications for the CFM56 shop-visit peak." Culp answered yes but declined to guess the quarter to which it would be pushed out. "But it's a positive dynamic for us in the aftermarket, both with existing platforms and increasingly with the LEAP," Culp said.

In other words, the delay in LEAP engine deliveries could generate more lucrative aftermarket revenue for CFM56 and LEAP engines already in service.

An issue over the long term?

While acknowledging that there could be some near-term positives from LEAP engine delivery delays, it's important to note that GE Aerospace doesn't want that to occur. Engine delivery delays push out the cash flows from aftermarket revenue.

Image source: Getty Images.

Still, some context is necessary here. Airplane engines can be used for more than 40 years, so the aftermarket earnings and cash flow will be stretched over many years. As such, a delay of 200 engines over six months (CFM delivered 1,570 LEAP engines in 2023) is unlikely to affect long-term earnings and cash-flow-based valuations greatly.

All told, while potential delays are not great news, they're not as big a deal over the near and long term.