Tuesday, Aug 31st 2021

We've initiated a position in aerospace leader Safran

Investor Update

Start your engines. Titan’s Offshore portfolio now includes Safran (SAFRY), one of the largest aerospace companies in the world. Safran holds leading market positions in the aircraft propulsion, aircraft equipment, space and defense markets, making it a very attractive addition to our Offshore strategy. Safran and GE’s joint venture, CFM International, is one of the most successful aerospace engine franchises in the world, with a staggering 75% market share of global narrow body aircraft engine production.

Safran is currently trading at a valuation of 12x 2022 EV / EBITDA, which is attractive on both an absolute and relative basis and well below its 3-year historical average. Safran’s valuation arguably warrants a premium over its peers and should see a multiple re-rating given the company’s dominant competitive position, consistently higher operating metrics, and much higher growth expectations.

We are proud to invest our clients in Safran as the company approaches what we believe is a major inflection point.

There are three main components underpinning our SAFRY thesis:

1) Commercial aerospace is a secular growth market and Safran controls 75% market share in the highest barrier to entry part of the commercial aerospace value chain: narrowbody engines.

  • With commercial aerospace having grown at mid-single digits for the past 50 years and global passenger volumes historically levered at 2x GDP, we expect this robust growth to continue, with narrowbody aircraft growing at a compound annual growth rate of 5%+ between 2021 and 2030.

  • As an aircraft engine manufacturer, Safran operates in a duopolistic industry with rational competition, possesses sustainable advantages over potential competitors, and is equipped with exceptional staying power which limits the risk of disruption from new entrants to the market.
  • Safran holds very strong competitive positioning within the commercial aerospace market due to the significant upfront fixed costs, long product cycles (10 years+), and long-term airframer contracts associated with narrowbody engine production.

Graph1 Source: Oliver Wyman

Graph2 Sources: Company Filings, Bloomberg, IATA, Morgan Stanley

2) Safran’s LEAP engine is poised to become a key driver of revenue and profitability growth.

  • Safran’s transition to the LEAP engine has involved operating with a negative production margin due to the high fixed costs inherent to manufacturing and assembling new aircraft engines.
  • As Safran has scaled production and accelerated its learning curve timeline, the company has been able to reduce UNIT engine costs by over 50% over the past three years.
  • With more than 15,000 units of current backlog and improved operating costs efficiencies, Safran now expects the LEAP engine to reach breakeven and begin operating at a profit in 2023/2024.
  • As Safran continues executing this dynamic fleet transformation strategy from the CFM56 to the LEAP engine, we believe the next-generation LEAP engine will be a key driver of revenue/profitability growth, contributing more than $1B in operating income by 2024/2025.

Graph3 Sources: Company Filings, Bloomberg, IATA, Morgan Stanley

3) We believe Safran’s aftermarket/servicing business is reaching an inflection point.

  • Safran’s aftermarket division is an attractive “razor and blade” business model, with 98% of engine sales flowing through to engine aftermarket servicing.

  • Importantly, the aftermarket/servicing industry is highly regulated with Federal Aviation Administration approval required for all aircraft parts, components, and engines before use in servicing and maintenance. As a result, Safran maintains a protected competitive position, as key suppliers for Airbus and Boeing’s MRO (maintenance, repair, overhaul) services.
  • As of 2021, Safran’s installation base consists of 35,000+ CFM56/LEAP engines in service, with an average age of 8 years. The fleet age profile is critical because the FAA requires aircraft engines to undergo scheduled maintenance once the engine reaches ~20,000-25,000 hours – typically between 8-10 years after the engine’s first flight.
  • Based on our research, we estimate that 45% of these CFM56/LEAP engines have not undergone their first scheduled shop visit, while 40% have had only one shop visit to date.
  • Given the high-margin nature of the aftermarket business — CFM/Safran earns ~60% margins on spare parts, and ~20% margins on MRO services — we expect increased aftermarket service volumes to be a key driver of earnings growth, as evidenced by the 15% earnings-per-share compound annual growth anticipated between 2021-2024.

Graph4 Sources: Company Filings, Bloomberg, IATA, Morgan Stanley

We have strong conviction that SAFRY stock could reach $49 by 2023: 60% upside / 20%+ IRR from today’s prices

We believe that Safran offers an attractive value proposition, enabling our clients to potentially capitalize on the secular growth of commercial aerospace. By investing in one of the leading aerospace engine manufacturers with dominant market share, compelling unit economics, and multiple growth drivers, we have strong conviction that Safran stock could reach $49 by 2023, translating to 60% upside / 20%+ IRR from today’s prices.

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