General Electric's Untapped Opportunity in Aviation

By Markets Fool.com

General Electric Company estimates that its next generation LEAP jet engine is expected to save $1.2 million per plane, per year, in fuel costs. Image source: CFM International, a 50/50 joint venture owned by General Electric and Safran.

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When it comes to jet engines, General Electric (NYSE: GE) is an industry heavyweight. The company has an unparalleled understanding in material science, advanced manufacturing, turbomachinery, and harsh environments. These areas of expertise are why its next-generation LEAP jet engine, which was co-developed with Safran, is 15% more fuel efficient than its predecessor, and has an order backlog of over 11,000 units, making it the fastest selling product in aviation history.

By 2020, GE hopes to have more than 44,000 commercial engines in operation across the world, up from 35,000 today. This installed base of engines represents a tremendous opportunity for the company to generate recurring revenue streams and drive margin growth while they're in operation.

A razor-and-blades model

Investors can think of GE's jet engine business as a razor-and-blades model, where each sale of engine fuels the subsequent sale of ancillary services over the engine's life. These services can range from scheduled maintenance and complete overhauls, to real-time monitoring services that tap into the company's digital offerings.

Although GE doesn't regularly break out the margin profile of its aviation services business, CEO Jeff Immelt once noted that the company's industrial services revenue generally commands a 30% operating margin.

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During the first half of 2016, GE's entire aviation segment generated a 22.5% operating margin, an 80 basis-point improvement from the same period last year. GE's aviation revenue went from being split 51% services and 49% equipment in the first half of 2015, to 56% services and 44% equipment in the first half of 2016.

Image source: GE.

Reducing off-wing time

In recent years, GE has been emphasizing its digital offerings that harness the power of the Internet of Things to drive productivity and efficiency improvements for aviation customers. For older planes, data is taken off of the engines after it lands, while newer planes can have data sent to GE's cloud-based services in real time.

According to GE Aviation CEO David Joyce, aviation customers who have enrolled in GE's digital programs experienced a 25% improvement in unscheduled disruptions. In one instance, Emirates, a major GE Aviation customer, reduced disruptions and planned maintenance by 43% year over year during the first half of 2016. These reductions resulted in 12 additional days of utilization across Emirate's fleet of Boeing 777s during this time.

In other words, GE's digital offerings are helping aviation customers keep GE's engines in service and on the wing for longer, which saves on costs and improves efficiency.

A young fleet and massive backlog

Of GE's 35,000 engines currently in service, more than 61% of them have seen one shop visit or less. As this installed base ages, it's inevitable that more engines will need servicing, giving GE an opportunity to realize revenue that's already sitting in its backlog. At the close of the second quarter, GE had over $156 billion in its entire aviation backlog, with services making up nearly $122 billion.

Image source: GE.

While it remains unknown what percentage of its engines subscribe to GE's digital offerings, it's likely within the early innings. GE Aviation's push into digital services is a relatively new initiative and Joyce said that the company is "making great progress" in "starting to connect data acquisition as part of our service contracts."

Looking ahead, GE Aviation is expected to expand its digital offerings, subscriber base, and installed base of engines in operation. Ultimately, these factors will give GE a greater opportunity to generate more services revenue from its engines in the field. This, in turn, could lead to an improvement in GE Aviation's operating margin, if its services revenue continues making up a greater percentage of its overall revenue.

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Steve Heller has no position in any stocks mentioned. The Motley Fool owns shares of General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.