Aerospace equipment suppliers like GE Aerospace (NYSE: GE) aren't always the easiest to evaluate. That much is apparent from GE's recent results and the consequent sell-off in the stock. While there were some negatives, the market may have missed a significant plus from management's commentary. Here it is, and here's why it matters.

How GE Aerospace makes money

The good news comes from an extension in how long GE expects a peak of "shop visits" to last on its legacy airplane engines installed in airplanes already flying. To put that into plain English and explain why it matters so much, it's essential to understand how GE makes money.

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GE's management has expressed dissatisfaction with the business model of selling airplane engines. These engines are typically sold at a loss, and the real money is made in the aftermarket, which can span over 40 years of an engine's lifetime. Aftermarket services revenue is primarily generated through shop visits, whereby engines are brought in for comprehensive overhaul and maintenance.

However, it takes many flight hours, and usually years, before engines come in for a shop visit. As such, when GE releases a new engine, it will still rely on the aftermarket revenue from the legacy engines on older planes for many years, until the aftermarket services revenue from the new engines starts to kick in.

The LEAP is replacing the CFM56

The newest narrowbodies engine from GE's joint venture with Safran, CFM International, is the LEAP, responsible for powering the Airbus A320 neo family, the Boeing 737 MAX, and the COMAC C919 airplanes. Since its first delivery in 2016, the LEAP engine powers a new generation of airplanes, and will be the key revenue generator for GE in future. However, CFM's CFM56 powers the legacy Airbus A320 family and Boeing 737 airplane. GE's narrowbody aftermarket services revenue will migrate, over time, from the CFM56 engine to the LEAP.

This was shown in the investor day presentation in March, when management forecast that peak shop visits for the CFM56 would be in 2025, followed by a sequential downtick in 2026 and 2027.

At the same time as CFM56 shop visits are expected to peak, LEAP engine shop visits will grow as engines are run, leading to services revenue from the LEAP gradually replacing services revenue from the CFM56. The following chart from the March presentation illustrates this.

Why the market sold off GE Aerospace stock recently

It's no secret that a mixture of ongoing supply chain issues in the aerospace industry and fewer than expected airplane deliveries at Boeing and Airbus has resulted in a slowdown in LEAP engine deliveries. While that's "good" news for GE's earnings over the near term, as the engines tend to be loss-making, it's not what GE wants because it pushes out earnings and cash flow from aftermarket services on the LEAP.

GE started the year expecting a 20% to 25% increase in LEAP deliveries but has cut expectations every quarter, with the latest update calling for a 10% decline in 2024. That's probably why the stock sold off recently.

What the market missed

While the LEAP engine delivery delays are negative, they are not a consequence of issues with end demand. Airlines are still expanding routes and flight hours. As such, older planes are being run more, which means airplane engines, notably the CFM56, are also running more.

Consequently, GE Aerospace CFO Rahul Ghai recently updated investors on the trajectory of shop visits for CFM56 engines. Instead of visits peaking in 2025 and then sequentially declining, Ghai now expects a "peak of shop visits in '25, but now to stay at that level to '27 and then start declining from that point on, again, at a gradual pace."

The extension of peak shop visits on the CFM56 means the engine will contribute more to service revenue than was implied in the investor day presentation (see charts above). In addition, management estimates that second and third shop visits generate 30% and 25% of an engine's lifecycle revenue, compared to 20% for the first shop visit. Consequently, GE has a growth opportunity if an extension of peak shop visits on the CFM56 leads to more second and third shop visits before an engine is retired.

What it means to investors

While the delay in LEAP engine deliveries is disappointing, ongoing growth in flight departures means more service revenue from the CFM56. That's a plus from the recent earnings, and with commercial engine services orders growing 33% year over year in the first nine months, GE has plenty of growth prospects.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The Market Missed Something Important in GE Aerospace's Big News. Here's What You Need to Know. was originally published by The Motley Fool