GE Owns Half of a Jet Engine Maker. What a Bear Thinks Investors Should Know.

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Sometimes, an analyst looks at what’s going on outside a company to figure out what’s going on inside. A case in point is French aerospace company Safran and General Electric, partners in an engine-making venture.

J.P. Morgan

analyst Stephen Tusa wanted to get a handle on

GE

‘s aviation business so he decided to pore over Safran’s financials. He didn’t like what he found, and explained why in a note Monday.

Investors acted like they didn’t really care about what Tusa had to say—shares of General Electric (ticker: GE) closed up 1.4%, just a hair behind the S&P 500’s 1.5% gain. Still, they might not want to be so fast in shrugging him off since one thing he drilled into was Safran’s outlook.

The name of the joint venture—Safran (SAF. France) and GE are equal partners—is Cincinnati-based CFM, an aerospace engine maker with thousands in its backlog. CFM engines propel both

Airbus

(AIR.France) A320 NEO and

Boeing

(BA) 737 MAX jets.

Tusa has essentially two takeaways after reviewing Safran’s numbers and outlook: Safran is now decidedly more downbeat about the commercial aviation business, which was decimated by Covid-19, than it last year. And GE’s accounting for commercial aviation service sales is off.

First, the air traffic projection. Safran, wrote Tusa, “lowered its long-term forecasts for traffic in [2030] by 15% to 20% from last year to reflect the downturn and their view of a protracted climb out.”

Safran isn’t the only one to doubt how quickly the aerospace industry will recover from the pandemic’s fallout. About 1.5 million passengers flew commercial in the U.S. on Sunday, down about 37% from 2019 but up almost 1200% from 2020.

Secondly, GE’s accounting. After digging deep into Safran’s figures, Tusa concluded that GE might be accounting for more than its fair share of joint venture sales. The word might is key because, as the analyst pointed out, “CFM remains an opaque shadow in the GE ecosystem.”

The companies really can’t be blamed for the lack of transparency. CFM is a 50/50 venture, and neither GE nor Safran consolidate CFM’s engine sales on their books. Complicating matters even more, GE and Safran both recognize service sales for CFM engines in their financial statements. GE and Safran supply different spare parts, so if a CFM engine needs a GE part then GE gets the sale.

The companies really can’t be blamed for the lack of transparency. CFM is a 50/50 venture, and neither GE nor Safran consolidate CFM’s engine sales on their books. Complicating matters even more, GE and Safran both recognize service sales for CFM engines in their financial statements. GE and Safran supply different spare parts, so if a CFM engine needs a GE part then GE gets the sale.

In the past, GE said about 40% of aviation commercial aftermarket sales come from servicing CFM products powering single-aisle jets like a 737. The 40% statistic is from 2019, applying it to 2020 commercial aviation service sales yields a potential CFM result of about $3.4 billion. GE’s total commercial aviation service revenue in 2020 came in $8.2 billion. Service revenue including military aftermarket sales was $13.5 billion.

Tusa figures roughly 50% of Safran commercial jet engine sales are from parts and service on comparable engines. That works out to about $4.4 billion in CFM service sales for Safran in 2020. That calculation implies GE’s CFM aftermarket sales are smaller than Safran’s.

GE helped Barron’s understand the accounting, pointing out that Safran and GE aftermarket sales don’t have to match. GE makes two parts—the compressor and the high-pressure turbine—for two CFM engines, and those parts get replaced more frequently, according to a company update that Barron’s was referred to. “Therefore, GE has historically recorded aftermarket spare part revenues that are greater than 50% of the total aftermarket parts sales for CFM56 and LEAP engines.”

Safran didn’t respond immediately to a request for comment. J.P. Morgan told Barron’s Tusa wasn’t available to expand on his research note.

Overall, investors should know that all the numbers are roughly where they should be. Safran’s consolidated commercial aviation service revenues fell about 31% in 2020 to about $5.6 billion. General Electric’s total aviation service sales fell about 33%—figures that match up with the difficult operating environment.

Tusa qualifies as a longtime GE bear, even though he rates shares the equivalent of Hold. His $5 per-share price target is the lowest on Wall Street. The highest is $15.50.

The rest of his peers aren’t so bearish. Overall, 55% of analysts covering GE stock rate shares Buy. The average Buy-rating ratio for stocks in the Dow Jones Industrial Average is about 60%. The average analyst price target, excluding the lowest and highest, is about $13.50. GE shares are at $13.44 in late trading.

Write to Al Root at allen.root@dowjones.com