Published Last Week

GE Aerospace and the Engine Aftermarket

Two statistics about the commercial aerospace market recently caught our attention: 

1. The current widebody and narrowbody production rate is still at 2012 and 2017 levels, respectively. There are not enough passenger planes to meet demand. Lessors and engine OEMs don’t expect commercial supply and demand to be balanced until at least 2030.

2. ~70% of the CFM56 fleet has had zero or 1 shop visits (out of 3 shop visits over ~25 years). There is a long tail of demand for engine shop visits and spare part sales. 

This led us to explore two questions:

  1. How sustainable is the airframe ‘undersupply’ and what could cause an oversupply?
  2. Will CFM56 engines see the full 3 shop visits? And if not, how may this impact GE / Safran earnings?

The passenger airframe market is undoubtedly undersupplied today due to the COVID overhand and Boeing's production issues. However, there is potentially a more subtle reason the market is persistently undersupplied: engine OEMs slow down new engine deliveries which are typically tied to new aircraft. 

Slowing down new engine deliveries enables the older engines to fulfil the 2nd and 3rd shop visits. These later shop visits are critical for engine OEMs to sell expensive LLPs and other spares that drive the return on the upfront R&D. Even if the airframer wanted to push out more, new aircraft, it would be economic suicide for the engine OEM to replace its old engines and lose profitable shop visits.

In effect, the commercial aero market is persistently undersupplied so both the airframer and the engine OEM can both earn adequate returns on their capital. 

How may this change over the next 5-10 years? 

A Former Chief Engineer at GE, who was heavily involved in designing both the CFM56 and the LEAP, highlights the potential risk of COMAC launching a new engine over the next decade: 

GE has three LEAP engines; 1A, 1B and the 1C, which is the COMAC derivative. Now the LEAP 1C is the same as the LEAP 1A which is what's on Airbus, but we have sold the LEAP 1C to China because it's on COMAC, etc. The Chinese bought the engines so that they could learn the technology. So what they've done and, and they've done this within three years of them getting their first LEAP 1C, they built an equivalent Chinese engine that looks awfully like a LEAP 1C. - Former Chief Engineer at GE Aerospace

COMAC seems to have directly copied GE engine intellectual property:

We have GE90s in China, and they didn't initially understand how it worked. They built a rig by copying our drawings and using service manuals, as the engines need to be there for overhauls. They constructed the offtake system and tested it at a university to understand how the air comes off the center of the compressor, moves through a vortex tube, and feeds the stage two blade. They pieced it together from running tests, and I saw a paper on this presented at ASME about five to 10 years ago. Their tactic for gaining information involves working it out from shop manuals or by dismantling engines. - Former Chief Engineer at GE Aerospace

GE Aerospace earns ~10% of revenue from China. While COMAC will still need to get FAA approval to fly internationally, if it can produce airframes or engines to dominate the domestic Chinese market, this may distort the persistent undersupply in the commercial aero market.

A commercial engine has a ~25 year life with 3 shop visits roughly equally split in terms of revenue generated. Each shop visit generates significant profit for CFM, mainly from the sale of HPT blades and LLPs. 

GE Investor Day, 2024
GE Investor Day, 2024

If CFM loses the final shop visit because airlines retire the CFM56 and shift to the LEAP, this will significantly impact GE and Safran profitability. However, the total cost of ownership of a CFM56 may still be attractive to airlines due to its simpler engine architecture and cheaper materials. This comment is also bullish for FTAIs business model: 

One thing to consider is the cost of ownership of a CFM56, whether it's a 5B or a dash 7. The cost of ownership for these is tertiary compared to a LEAP engine because the LEAP is larger and has more parts. A classic CFM engine has one fan, three low-pressure compressor stages, one high-pressure compressor stage, a single-stage high-pressure turbine, a combustor, and typically a four-stage low-pressure turbine. So, you have a limited number of engine parts, and they're all low technology. I mean all the rotors are internal, and the material used, Inconel 718, is the cheapest available on the open market from an engine perspective. It has no significant cost. All of your LLPs in these engines are Inconel 718, which means low cost of ownership - Former Chief Engineer at GE Aerospace

We also explore the recent LEAP HPT issues and the bargaining power between GE and Howmet through a story of how GE tried to switch nozzle castings to a smaller casting house:

A few years ago, GE proposed something that shocked me. They considered going to a company called Hitchiner as a new casting vendor and planned to take all of the LEAP business there. I was shocked when I heard GE was planning that. The technology we've developed has been a collaboration over many years. CFM has been around for 50 years. When I first joined GE in 1985, we were just experimenting with single crystal technology, which was a steep learning curve. At that time, we had just released the CFM 56-5A design and faced issues with N4 nozzles. The HP turbine nozzle casting wall would pop out, affecting the engine's throat area, A4. This caused engine stalls. Air Canada experienced significant problems with these nozzles. We conducted major investigations into the alloy's issues. Over time, we learned how to reinforce the ribs, manage cooling air, and coat the airfoils. This technology allowed for higher operating temperatures than conventional alloys. It was a significant learning experience that created a bond among us. - Former Chief Engineer at GE Aerospace

The interviews go on to explore the cost of switching from Howmet and how GE looks to combat supplier pricing power.  

Intuitive Surgical: Instrument Remanufacturing Competition

In many ways, Intuitive Surgical is similar to aircraft engine manufacturers like GE Aerospace. Both companies own proprietary technology underpinned by strict regulatory systems. Both also have an installed base of systems in the market which they serve with spare parts and service contracts. GE sells $20k HPT blades and Intuitive sells monopolar scissors and scalpels. A classic razor razor-blade model. 

As we discussed for GE above, spare part and service sales to the installed base is critical for OEM profitability. It’s also critical for Intuitive: ~70% of revenue is from instrument and service contract sales. 

A major risk to an OEM with an installed base is a third-party offering customers cheaper parts or servicing. In the aerospace aftermarket, PMA companies like HEICO or Chromalloy pose such a threat. For Intuitive, a company recently received a 510(k) clearance, an approval similar to a PMA, to remanufacture monopolar scissors, Intuitive's highest-selling instrument. Intuitive sells its scissors to hospitals for ~$3,300 for 10 uses. 

Intuitive Surgical Product Catalog
Intuitive Surgical Product Catalog

This interview with the CEO of a remanufacturer of Intuitive scissors explores how the company reverse engineered Intuitive's monopolar scissors:

We've been collecting instruments from hospitals for many years, and it's been a process. We have to establish an agreement with the hospital to get them to send us their instruments. Then, we analyze those instruments to determine if they are candidates for remanufacturing. There's an extensive cleaning process that involves soaking, autoclaving, force washing, ultrasonic tanks, steam cleaning, and inspection. The first step is ensuring they're safe to handle. The next step is a visual inspection to check for any obvious damage, such as broken shafts, cables, or scissors damage. They are then sorted based on the damage. We've collected tens of thousands of instruments over a few years. - CEO of Intuitive Surgical Instrument Remanufacturer

After receiving a 510(k) clearance, the remanufacturing company is selling the same set of scissors for ~20% cheaper than Intuitive catalog price: 

we're offering a $672 discount off the $3,360 price. The monopolar scissors are by far where they have the biggest spend. (...) it drops off significantly after that. There are several that are used in 5% to 10% of cases, but nothing comes close to the monopolar scissors. - - CEO of Intuitive Surgical Instrument Remanufacturer

The monopolar scissors are the first and hardest instrument to reverse engineer for approval. The company has plans to seek approval for all Intuitive instruments over the coming years: 

Our approach was to tackle the most difficult instrument first, which happened to be the one used the most. If we could handle that one, the next ones would be easier and faster. Tackling the hardest first would show us the path forward. [The hardest instrument is] the monopolar scissors in the EndoWrist family. It involves energy-based technology and scissors that cut, and it gets the most use in a case. For example, a needle driver might be used for 20 seconds, while the monopolar scissors could be used for four hours. Understanding everything about that instrument and its challenges helped us figure out the path forward for all the instruments. - CEO of Intuitive Surgical Instrument Remanufacturer

We plan to explore this threat to Intuitive in more detail over the next two weeks.