MTU Aero Engines Can Fly Out Of Turbofan Crisis (OTCMKTS:MTUAF)

MTU Aero Engines (OTCPK:MTUAF, OTCPK:MTUAY) suffered a setback following the metal powder issues with the Pratt & Whitney GTF. As a risk sharing partner, part of the cost burden is carried by MTU Aero Engines, which has affected the company’s financial results in 2023 and will have cash impacts going forward. However, as I discuss in this report the adjusted figures are looking promising and as the GTF impact is gradually being recognized in the cash flow performance, we should see the underlying performance radiate once again. Based on this, I will be re-assessing my stock price targets and rating for MTU Aero Engines.

MTU Aero Engines Investors Were Given An Attractive Entry Point

The snapshot above shows my rating history on MTU Aero Engines, and it suffices to say that my first two ratings over the past twelve months have not quite worked out as expected due to the GTF engine issues. However, the buy rating for MTU Aero Engines in October 2023 has proven to be a very rewarding entry point as the stock rebounded 28% compared to a 15% return for the S&P 500. Not all companies with a beaten down stock price provide continued compelling investment opportunities, but it seems that MTU Aero Engines was not in that group.

MTU Aero Engines Adjusted Earnings Show Strong Growth

Adjusted revenues for 2023 showed 19% growth to €6.3 billion, excluding the €956 million revenue impact recognized earlier. Similarly, EBIT adjusted grew 25% to €818 million. The adjusted margin expansion was primarily driven by a lower share of the GTF in the mix, which provides a tailwind to margins. Free cash flow grew 8% but fell short of the EBIT and revenue growth driven by higher taxes, partially offset by lower changes in working capital.

The OEM segment saw its revenues grow 21% with military revenues up 8% and commercial revenues growing 25% contributing to a 26% growth in EBIT with the business mix driving the margins slightly higher from 21.1% to 22.1%. Commercial MRO revenues grew 17% with EBIT adjusted growing 23% with margin expansion from 7.4% to 7.8%. Drivers of the EBIT margin were a lower share of GTF, which has lower margins, a strong business mix otherwise and positive contributions from equity companies.

So, on adjusted basis, we do see very strong results both in terms of revenues and income. Free cash flow performance trailed somewhat due to higher taxes paid during the year. Overall, the underlying business (meaning excluding GTF impact) is performing well and that provides bright prospects for the future.

For 2024, MTU Aero Engines is guiding for organic revenue growth to be up to low mid-teens for Military, pointing at an acceleration in revenue growth driven by deliveries and more revenue recognized from the Future Combat System. Commercial OEM sales are expected to be up low to mid-twenties driven by higher production rates on the Airbus A320neo, Airbus A229, Embraer E-Jets and Boeing 787 with the GE9X powering the Boeing 777X also adding to sales. Spare part sales are expected to be up low teens, driven by utilization of legacy engine platforms and continued list price increases for said engines. Commercial MRO revenues are expected to be up mid to high teens, with a higher share for the GTF at 40 to 45 percent.

This should bring the Group Sales to €7.3 billion to €7.5 billion, providing over 18.5% growth in revenues. Adjusted EBIT margins of >12% point at a minimum of 7 to 10 percent growth. The free cash flow guidance of low trip digit million is somewhat vague, but I would say this is fully understandable given the timing of customer credits that MTU Aero Engines as a shareholder of International Aero Engines will grant to airline customers. A recent example is the compensation agreed on with Spirit Airlines (SAVE). The timing of the compensation is not fully certain as some might be in 2024 and some might end up in 2025 or there actually might be an acceleration causing a front-loaded cash outflow. Either way, from cash flow performance, I do expect a pressured year as customer compensations are being rendered.

MTU Aero Engines Is Not To Blame For GTF Engine Crisis

As I have been covering MTU Aero Engines for a while, one returning comment that I have received from readers is that MTU Aero Engines was responsible for the metal powder issue. I do not know where this rumour came from, but it is important to be aware that this is not the case and MTU Aero Engines also confirmed this:

As previously said, I would like to emphasize that MTU is not part of the problem, but we are part of the solution. We are working very closely with Pratt & Whitney to manage the plan in the best possible way as we are assessing options how to increase MRO capacity and to develop intelligent and smart solutions to manage shop visits and optimize workshops. The defining factor for the program remains the ability to speed up turnaround time and to ensure capability of exchange parts.

As a risk sharing partner, MTU Aero Engines might not have caused the problem but is obliged to provide customer credits. I think it is very important for those that assume that MTU Aero Engines caused the metal powder issue to be well aware of this and be informed that MTU Aero Engines is actually not the cause of the problem with the GTF. MTU Aero Engines has said it will not sue Pratt & Whitney, but that does not mean that MTU Aero Engines will not receive any compensation from Pratt & Whitney at all as talks regarding compensation continue.

MTU Aero Engines Stock Remains Attractive

MTU Aero Engines had strong earnings in 2023 on an adjusted basis, and its earnings in the years to come are likely reflective of strong demand for air travel as well as an uptick in military business revenues. However, its free cash flow will be subdued driven by the GTF engine issues and as a result, the company has lowered its dividend from €3.20 previously to €2.00. I believe that is a prudent decision given the additional cash outflows, and it provides MTU Aero Engines with a dividend basis from which it can return value to shareholders again once free cash flow starts to return to growth.

After processing the balance sheet data and forward projections, I believe that MTU Aero Engines remains attractive, with a $298 price target providing 28% upside.

Conclusion: MTU Aero Engines Navigates Pressures Well

MTU Aero Engines is seeing strong underlying performance and that is unlikely to change any time soon as demand for turbofans remains high while military projects are also about to accelerate revenue generation. In the coming years, free cash flow will be pressured due to customer credits that MTU Aero Engines has to provide to operators of the troubled GTF engine. However, even in that scenario, I believe that the investment case for MTU Aero Engines remains attractive for the near term as well as the longer term and that is without accounting for any compensation the company could eventually get from RTX Corporation (RTX), which is the company’s program partner. Furthermore, the company sees growth opportunities as several commercial production programs go up in production rate and the engine business remains one that is hard to penetrate for new players. As a result, I do believe that while the GTF issues provide a cash drag on MTU Aero Engines, there is sufficient appeal to invest in the company.

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