EUR 850.00 For Business Accounts Only

Morningstar | Raising Safran FVE Due to Stellar Growth of Leap Deliveries in First-Half 2018

Having updated our sales and profit estimates for wide-moat Safran after stellar first-half results (ahead of our and the market's expectations), consolidation of the Zodiac Aerospace acquisition, and adjusting for the time value of money, we are increasing our fair value estimate to EUR 110 per share from EUR 99. As expected, deliveries of CFM56 engines declined (591 in the first half versus 710 a year ago) as airframes like Boeing and Airbus transition production towards neo and Max aircraft. However, the large installed base of CFM56 units and the ramp-up of the next-generation Leap engine (438 delivered, up from 147 the previous year) open the door for strong and highly profitable aftersales in coming years. We believe the shares are fairly valued.

In the first six months of 2018, Safran's adjusted revenue rose 23.9% year over year (10.1% on an organic basis), fuelled by continued strong momentum in aerospace services (notably civil aftermarket up 12.5% in U.S. dollar terms, driven by CFM56 spares sales and service contracts). Aerospace propulsion revenue grew 12.9% organically, benefiting from strong momentum in narrow-body engines and helicopter turbine support activities. Increased deliveries of nacelles for the A320neo (172 units in the first half versus 105 a year ago), along with strong sales of wiring shipsets and landing gear for the Boeing 787 and Airbus A320 family, boosted Safran’s aircraft equipment revenue. Sales momentum in defense continued apace, up 9.2% year over year on an organic basis, mainly owing to increasing military guidance systems and avionics sales. The firm’s adjusted operating margins increased 100 basis points. We view this as a good result, as Safran had to overcome negative-margin Leap engine sales and lower volumes in the profitable CFM56 engine.

We are happy with the increased production of the Leap, Safran's next-generation engine, as the firm extracts high-margin aftersales services of the large installed base of engines and brakes that it successfully built in the first half of 2018 and previous years. Year to date, Safran has delivered 438 units to Airbus and Boeing, and is on track to deliver our expected target of 1100 Leap engines in 2018. The combined backlog of the CFM56 and Leap engine programmes amounts to close to 16,000 engines, more than seven years of production, and we expect solid execution on delivering and maintenance of these engine.

The firm is in the sweet spot of the aftermarket cycle, benefiting from an acceleration in the number of overhauls of its installed base of more than 30,000 CFM56 engines, which drive demand for high-margin spares. That said, we see headwinds for Safran, namely short-term margin dilution from mix changes as production of the Leap engine ramps up while the mature and profitable CFM56 program ramps down. We expect these transition CFM56-LEAP engine costs to be in the range of EUR 100 million-EUR 150 million. However, we expect adjusted recurring operating income (excluding Zodiac Aerospace) to grow by 15% in 2018, owing to equipment, or OE, volume growth, reduction of research and development expense (approximately EUR 100 million less spending on LEAP 1B for B737MAX), productivity improvement, and high-margin civil aftermarket growth.