This piece explains why GE Aerospace's jet engine business is a good investment. The author says GE uses a 'razor-blade' model: it loses money selling engines but makes big profits from maintenance, with 70% of revenue from services that have 40-50% margins and 25-year visibility. It's bullish on GE, which powers three out of four commercial flights. Key holdings: GE Aerospace (core holding, 70,000 engines installed), Safran (JV partner, stable margins), and Pratt & Whitney (rival, lost share from 60% to 20% due to quality issues).
At a Glance GE Aerospace (General Electric Aviation) is the subject of this Business Breakdowns episode, led by Ramesh Narayanaswamy, co-founder of Tourbillon Partners. The discussion focuses on the investment thesis following its transformation from a diversified conglomerate into a pure-play aviat
Presented by Ramesh Narayanaswamy, co-founder of Tourbillon Partners, this episode focuses on the investment thesis behind GE Aerospace's transformation from a diversified conglomerate into a pure-play aviation business. Core thesis: The aircraft engine industry represents "one of the most difficult engineering challenges humanity has ever undertaken." With 70% of revenue coming from aftermarket services and aftermarket profit margins of 40-50%, GE has built a razor-blade business model where "equipment is sold at a loss but services generate profits," offering over 25 years of cash flow visibility.
Ramesh Narayanaswamy argues that manufacturing aero-engines is comparable in difficulty to semiconductor fabrication, biopharmaceutical production, and reusable rockets. The core challenge lies in simultaneously achieving extreme technical performance and ultra-low manufacturing costs.
"Within the hot section of the engine inside the high-pressure turbine, the temperatures can exceed the melting point of alloys," and the engine must withstand extreme thermal cycles, sand ingestion, bird strikes, and other harsh conditions. At the manufacturing level, "atomic scale defects can be catastrophic"—Pratt & Whitney's GTF engine suffered a global fleet recall due to microscopic contaminants discovered during production.
Historical evidence: Rolls-Royce nearly went bankrupt and was nationalized in the 1970s while developing the RB211 engine; despite its strong manufacturing capabilities, China's COMAC still chose GE/CFM engines to power its C919. Even highly experienced players and new entrants face enormous obstacles in this industry.
Ramesh notes that GE dominates the global commercial engine market:
| Segment | GE Market Share | Key Platforms |
|---|---|---|
| Narrow-body (short-haul) | ~70% | 737 MAX (100%), A320 NEO (~60%), C919 (100%) |
| Wide-body (long-haul) | ~50% | 787 (80% backlog), 777 (80%), 777X (100% exclusive) |
| Regional/Business jets | ~15% | Bombardier, Embraer |
Total installed base: Approximately 70,000 engines (45,000 commercial + 25,000 military). "GE power something like three out of four all commercial takeoffs pretty much every day."
Risk note: Ramesh warns of historical lessons—"Pratt & Whitney was maybe 60% of the commercial fleet in 1995, and now is less than 20%." Even giants can decline.
Ramesh emphasizes that the key to understanding GE's business model lies in two distinct customer groups:
1. Original Equipment (OE) Customers: Airbus, Boeing, COMAC — highly concentrated with strong bargaining power. GE sells engines at a loss or break-even. The LEAP engine has a list price of approximately $20-22 million, but the actual selling price is only about $6 million (a discount of 70-80%).
2. Aftermarket Customers: Hundreds of airlines — highly fragmented, giving GE a bargaining advantage. Aftermarket gross margins are around 60%, with operating margins potentially exceeding 40%.
"Over the life of an engine, the aftermarket can be three to four to five times the OE sale."
Ramesh distinguishes between two models:
| Model | Risk Bearer | Applicable Scenario | GE Share |
|---|---|---|---|
| Time & Materials (T&M) | Airlines | Mature engines | ~40% of LEAP |
| Long-Term Service Agreement (by flight hour) | GE | New engines | ~60% of LEAP (of which 30% is pure pay-per-hour) |
For wide-body aircraft, 60-70% are long-term contracts, with 60-80% of those being pay-per-hour.
Key Mechanism: If an airline uses non-OEM parts, it will lose the engine warranty. This gives GE a de facto monopoly in the aftermarket.
Data provided by Ramesh:
Key Insight: GE Aerospace's margin expansion is primarily driven by portfolio simplification (divesting loss-making businesses), rather than operational improvements. The commercial engine services margin had already been maintained at around ~20% before Larry Culp took over.
| Metric | Data |
|---|---|
| Capital Expenditure/Revenue | <3% |
| Capital Expenditure/EBIT | 10-15% |
| Earnings-to-Free Cash Flow Conversion Rate | ~100% |
| Cash ROTOCE (Adjusted) | 20-25% |
Ramesh emphasizes: The current low capital expenditure reflects a "harvest" phase in maturity — the LEAP engine has passed its most difficult R&D and early loss period, while the retirement of the CFM56 legacy fleet is slower than expected, providing a "cash buffer" for the LEAP ramp-up.
Comparable Companies: Safran ROIC 20-25%, MTU and Rolls-Royce 16-18%. GE's returns are not "stunning," but "what you lose in ultra high returns on capital, you make up for in durability and visibility".
Ramesh forecasts that commercial services revenue can maintain 8-10% annual growth over the next five years, driven by:
1. Air Travel Growth: RPK (Revenue Passenger Kilometers) historically grows at 2x GDP growth, and 3x in emerging markets
2. LEAP Fleet Expansion: The ultimate scale of LEAP is expected to be twice that of its predecessor, the CFM56
3. Aftermarket Pricing: Strong pricing post-pandemic, expected to maintain at least mid-single-digit growth through the end of this decade
4. Unreleased Maintenance Demand: Approximately 40% of the CFM56 fleet has not yet undergone its first major overhaul
Time Horizon: LEAP entered service in 2016, with a typical aircraft program cycle of 40 years and a useful life of 25 years — "still a very, very young program that will deliver earnings for decades to come."
Ramesh points out that the most prominent risk at present is "time on wing" and reliability. Pratt & Whitney's GTF is facing a global recall due to this issue, while the LEAP engine is still maturing toward the reliability levels of the CFM56. Although GE has benefited from Pratt's difficulties, once Pratt resolves its problems, market share could be given back.
Ramesh considers this the biggest structural risk:
"GE has gone all in on open rotor architecture... it could be a game changer for GE if they get it right." But this is a "higher risk and higher upside" bet, with the outcome depending on technological progress, choices by Airbus/Boeing, and airline acceptance.
Ramesh believes the threat is limited, for the following reasons:
1. Technical complexity: Pratt once attempted to manufacture PMA life-limited parts for the CFM56, reportedly losing billions of dollars, and ultimately failed
2. Leasing company resistance: Over 50% of the market is controlled by leasing companies, which oppose the use of PMA parts (as they void warranties)
3. Engine lifecycle: The true addressable market for PMA parts exists only in the latter half of an engine program and requires sufficient flight cycle data to support reliability
Ramesh argues: Valuation methodology itself is a signal of cycle positioning.
| Market Environment | Applicable Valuation Method | Logic |
|---|---|---|
| Crisis period (e.g., pandemic, financial crisis) | Liquidation value / NPV per engine | Each engine acts like an "inflation-protected bond," with predictable cash flows |
| Normal / mid-cycle | Cash flow / earnings multiples | Market prices based on growth expectations |
Current valuation: GE Aerospace trades at approximately 40x free cash flow. Assuming low-double-digit revenue growth and mid-to-low-double-digit EPS/FCF per share growth, this implies roughly 10x earnings in 10 years.
Ramesh's observation: "Value opportunities do arise either during a travel crisis... or during periods where there might be a stock-specific issue." In normal times, these stocks are priced higher due to growth certainty and scarcity.
| Position | Analyst View | Key Data |
|---|---|---|
| GE Aerospace | Bullish (Core Holding) | 70,000 installed units, $40B revenue, 70% service revenue share, aftermarket margin 40-50% |
| Safran | Neutral (Comparable Reference) | CFM JV 50-50 partner, 20% operating margin, positive free cash flow even during the pandemic |
| Pratt & Whitney (RTX) | Risk Warning (Competitive Reference) | 60% of commercial fleet in 1995 → now <20%, GTF powder metal issue leading to global recall |
| Rolls-Royce | Neutral (Comparable Reference) | 25% operating margin, nearly went bankrupt in the 1970s due to the RB211 |
| MTU Aero Engines | Neutral (Comparable Reference) | 25-26% operating margin, fell to 10-11x earnings during the GTF issue period |
| Heico | Neutral (PMA Reference) | Benchmark for PMA parts, but limited threat in the engine segment |
1. "The difficulty of manufacturing aircraft engines is comparable to semiconductor fabrication, biologics production, and reusable rockets" (Ramesh) — The high-pressure turbine in an engine operates at temperatures exceeding the melting point of alloys, and atomic-level defects can trigger a global fleet recall. This is the starting point for understanding the industry's barriers to entry.
2. "The divergence between buyer and user is a common pattern for many enduring businesses" (Ramesh) — GE's OE customers (Airbus/Boeing) are highly concentrated with strong bargaining power, but the end users (airlines) are extremely fragmented. New entrants must solve a "three-dimensional puzzle" simultaneously, greatly increasing the difficulty of entry.
3. "Over the full lifecycle of an engine, aftermarket revenue is 3-5 times the original equipment sale" (Ramesh) — The LEAP engine has a list price of $22 million, but the actual selling price is only $6 million (sold at a loss). However, a 25-year service period can generate several times that amount in profit. This is the ultimate version of the "razor-and-blade" model.
4. "Pratt & Whitney held 60% of the commercial fleet in 1995, but now less than 20% — even giants can decline" (Ramesh) — GE's current position is solid, but the next-generation engine technology path (open rotor vs. geared turbofan) will determine the market landscape for the next 20 years. This is the biggest structural risk.
5. "What is lost in ultra-high returns on capital is compensated for by durability and visibility" (Ramesh) — GE's adjusted cash ROTOCE is approximately 20-25%, which is not astonishing, but the cash flow visibility of over 25 years, mandatory regulatory maintenance, and monopoly on original spare parts make this return highly certain.
6. "During crisis periods, engine fleets can be valued like inflation-protected bonds" (Ramesh) — Each engine has a finite useful life, and the remaining cash flows can be discounted. During the pandemic and financial crisis, these companies traded below liquidation value. In normal times, they are priced using growth multiples.
7. "Larry Culp's management philosophy is 'the forceful application of common sense'" (Ramesh) — The lean manufacturing principles (Kaizen, Gemba walks) brought from Danaher focus on simplification, de-conglomeration, and customer orientation, stripping GE Aerospace out of the quagmire of diversification.
8. "The true addressable market for PMA parts in engines is far smaller than it appears on the surface" (Ramesh) — Technical complexity, regulatory certification, lessor resistance, and engine lifecycle stage limitations make it difficult even for excellent companies like Heico to replicate their success in airframes within the engine segment.