Safran SA (SAF) Earnings Call Transcript & Summary

Welcome to the Safran third quarter 2023 revenue (sic) [ results ]. At this time, I would like to turn the conference over to your host, Olivier Andries, Safran's CEO; and Pascal Bantegnie, Group CFO. Mr. Andries, please go ahead.

Good morning, everyone, and thank you for joining us to our Q3 2023 revenue conference. I'm here with Pascal Bantegnie, our CFO. Let us go straight to Page 3 with a summary of our talking points today. We post today a solid Q3 revenue growth, supported by strong market tailwinds with narrowbody air traffic now trending well above precrisis level, resulting in a strong demand for CFM56 spare parts and OE deliveries ramp up. We continue to navigate into a challenging macro environment. Supply chain constraints are persisting, especially in raw material and forging, casting that but still pacing our ability to ramp up production faster. Inflationary pressures remain at a high level so far with no real sign of losing steam. We have now completed the acquisition of Thales electrical systems activities. This acquisition reinforces Safran expertise, particularly in power conversion, strengthening our position as a leader in the entire aircraft electrical chain. At last, we confirm our full year 2023 outlook. I'm now on Slide 4. Civil aviation enjoys continued positive trend with narrowbody ASK now exceeding 2019 level by 107% in Q3 2023. CFM flight cycle also surpassed their 2019 level. Most geographies trend above 2019 level with a noticeable recovery in China while Europe, which includes a lower traffic in Russia and Asia Pacific outside of China, remain below 2019 level. In the context of undersupply of new generation aircraft and solid traffic growth, airlines continue to fly second-generation CFM56-powered aircraft as demonstrated by the very low level of retirements. 130 aircraft has been retired in 9 months in 2023. As a reminder, we were at 166 for the full year 2022. On Slide 5, let me share with you some of the main recent business achievements. CFM delivered 389 LEAP engines in Q3, reaching 1,174 deliveries over the first 9 months of the year. We have already delivered as many engines in 9 months as we did in the full year 2022. It is a major step up in production, representing a 45% increase compared to the same period last year. For the full year, we now expect deliveries to increase by 40% to 45% given the supply chain situation. Civil aftermarket continues to benefit from solid market tailwinds, strength in air traffic and insufficient aircraft capacity. Supporting our customers, enhancing the reliability of our products remained a key focus for CFM. We just announced the introduction of an upgraded HPT blade for CFM56 second-gen engine to maximize time on wing and provide fleet transition flexibility. As a reminder, these engines have a world-class dispatch reliability rate of 99.98%. On the Equipment & Defense side, we can highlight that Safran has been selected by Bell to develop the landing gear system on the U.S. Army's future long-range assault aircraft. We announced a collaboration agreement with Cuberg on battery systems for advanced electric aviation. Regarding long-term service agreements, in landing gear business, we just signed a 5-year contract to support nearly 60 A320 family operated by Wizz Air. And in Electrical & Power business, we signed a deal with Turkish Technic to support APU generators, engine harnesses, ventilation systems equipment for more than 500 A320s and A330s. On Aircraft Interiors, Safran Seats signed a new contract to equip the premium cabins of Japan Airlines on 13 A350s. I'm now on Slide 6. In Q3, revenue is up 26% year-on-year on an organic basis, a strong performance in dynamic end markets. In the first 9 months, revenue increased by the same growth rate, reaching EUR 16.8 billion, on track for our full year guidance. Let me now hand over to Pascal for more details on Q3 sales.

Thank you, Olivier. Good morning, everyone. Starting with FX trends on Slide 8. The third quarter was marked by strong volatility in euro-dollar with the peak at $1.12 in July and now trending towards $1.05. It did offer opportunities to continue hedging our exposure at attractive rates. Our book of $50 billion should cover our needs for the next 4 years, 2027 being almost fully hedged. By construction, we decided to cap the estimated net exposure at $13 billion from 2027 onwards. There is no business conclusion to draw from this decision. Q3 and 9 months have seen a weakening dollar compared to the euro compared to last year, which results in a negative translation impact. Turning to Page 9. Q3 revenues stood at EUR 5.8 billion, a solid 26% organic growth or 20% when taking into account the negative translation impact from the weaker U.S. dollar compared to last year. Service activities were up 33% organically, mainly driven by solid civil aftermarket growth, which is up 39% year-over-year and up 24% sequentially. OE was up 19% organically driven notably by higher LEAP engine deliveries year-over-year. Also, the net impact in revenue is not material. Change in scope reflects the divestment of cargo and catering activities from Safran Cabin last May. On Slide 10, let's go through the Q3 revenue per activities, starting with Propulsion, EUR 3.1 billion, up 28% organic. OE revenue was up 22%, mainly supported by an increase in helicopter turbines and LEAP deliveries. Services revenue was up 32% driven by a solid 39% growth in civil aftermarket revenue, which is a combo between volume, pricing and World Cup. Starting with volume. Volume of shop visits was up year-over-year and sequentially, and we confirm that we are on track to range -- to reach around 2,000 CFM56 shop visits this year. We also benefited from the price increase we had at 1st of August, and the World Cup was heavier with airlines performing a full World Cup maintenance when they come to the shops. High-thrust engine and spare part sales were also slightly up, and services continue to be a growing contributor to the civil aftermarket growth. It includes the contribution of LEAP engines and the revenue per flight hour contracts, which, as you know, has no margin recognition up to 2025. So on the back of this solid 9 months growth, 37.5%, we now expect civil aftermarket to be up in the low 30s in full year 2023, which compares to our initial guidance in the low 20s, which we raised in July to mid- to high 20s. In Equipment, EUR 2.1 billion revenue, up 21%. Services were up 30%, with good momentum across the board from spare parts for landing gears, MRO, carbon brakes and nacelles. OE revenue was up 16%, thanks to higher volumes in landing gear, both on A350, A320neo, power and wiring activities, FADEC deliveries but we also have to notice lower nacelles deliveries for the A320neos. Some OE sales continue to be impacted by supply chain constraints and revised demand by air-framers. Aircraft Interiors, EUR 600 million, up 31%. This is still about 25% below what we had in 2019. OE revenue was up 24%. Most of the increase came from Cabin, such as floor-to-floor activities for 787, A320 and some activities at Bombardier. Deliveries of business classes were down year-over-year as they remain affected by engineering delays in their certification process. On a sequential basis, they were up from 110 -- 112 units delivered in Q2 '23 to 174 units delivered in Q3 '23. Services in Aircraft Interiors was up 46% with very strong growth in Seats, notably with the refresh for Middle East Airline on the A380. Back to you, Olivier.

Thank you, Pascal. Let's go now to Slide 12. On the back of a solid 9-month performance, we reiterate our full year guidance after July 2023. As mentioned earlier, to reflect the 9-month trends, we are updating two underlying assumptions. Civil aftermarket revenue growth now expected in the low 30s given the strong dynamic in CFM56 spare part activities. LEAP engine deliveries are now expected to increase by 40% to 45% compared to 2022. On that basis, we feel comfortable to deliver our 2023 guidance. Thank you for your attention. Pascal and I are now ready to answer any questions you may ask.

[Operator Instructions] We'll now take the first question. This is from the line of George Zhao from Bernstein.

I guess, first on -- you've taken up civil aftermarket guide, lower LEAP deliveries, but the EBIT guidance is unchanged. Is that just conservatism? Or are there any additional offsets that led to their reiteration? And secondly, on the LEAP delivery. So delivery, they have been improving in H1. So what changed in Q3? Were there particular parts or components that became more challenging? And what does this mean for your ability to get to the 2,000 deliveries next year?

On civil aftermarket, so we raised our assumption for revenue growth in the low 30s. It's about 10 points better than the initial guidance we gave back in February. So it's a nice increase. We continue to enjoy a very positive combo, as I said, in volume, in pricing, which we had on the 1st of August, which is 3 months before we used to do, and work scope, which is heavier than expected. This is definitely a positive for our full year EBIT guidance. And I'm sure you've noticed the second positive is that if we were to deliver less LEAP OE engines than initially expected, there will be less losses, meaning more profit for the full year. So today, we are here to discuss revenue. We didn't provide an indication on the EBIT, neither free cash flow. There is clearly comfort to deliver for our full year guidance based on these two changes in our assumptions.

I will take the second one on LEAP deliveries. Yes, indeed, these deliveries are not accelerating as fast as we were expecting. If you remember well, our guidance was for a plus-50% deliveries compared to 2022. As we speak now, when I look at the 9-month performance, we are at plus 45% compared to 2022. And yes, indeed, basically, the outlook is for plus 40% to plus 45%, end of the year. The fact is that we are discussing every day with our GE partner as well. And as you can imagine, the LEAP deliveries are a function of our own supply chain performance and also our partners' supply chain performance. And yes, indeed, we can see persisting supply chain issues, especially on raw materials, forging and casting. And yes, indeed, this is pacing our acceleration. So for 2024, we are still targeting around 2,000 deliveries. As we see today, we see a plus 20% to plus 25% deliveries increase versus 2023, which basically puts us around 2,000. So this is still our target. Of course, we will manage very carefully the supply chain over the next month and come back at the beginning of 2024 to give you a guidance for the 2024 LEAP delivery then.

We'll now move to the next question. This is from the line of Olivier Brochet from Redburn Atlantic.

I would ask two questions. One follow-up on George's question on the OE side and the 45% increase. Is it focused on one aircraft type? Or is it spread across the two, you mentioned a different supply chain for yourself and GE, but they are also very different between the two aircraft types, I think. And second question, the competition on the A320neo is, to put it kindly, in a difficult position. How do you approach this situation? Some airlines are mentioning they cannot consider switching to LEAP as you are not offering service contracts. What is it you're doing there? Are you trying to win more market share? Are you trying to boost profits going forward?

Thank you, Olivier. On the OE side, we don't provide details between 1A and 1B. So I will not specifically comment on that. What I'd like to say is simply that as we speak, we are not pacing the aircraft deliveries. We are not, as we speak. And of course, we are focusing to ensure that in Q4 this will continue to be the case, not pacing the aircraft deliveries, and we are totally focused on that. On the A320neo competition, we are not looking for additional market share. As you know, we have a 60% market share on the A320neo backlog. And in the last 1 year [ in life ], basically, our win rate was around 70%. So frankly speaking, we are not looking for additional market share. We rather, are focusing on basically making sure that basically we can strike deals at good economic condition. That's our focus.

We'll now take our next question. This is from the line of Ian Douglas-Pennant from UBS.

It's Ian, UBS. So firstly, in the -- continuing on from your last comments on pricing, could we shift to aftermarket. Could you talk about how you see the pricing outlook in aftermarket going forward? And within that, would you consider increasing prices again off-cycle in Q1 of next year? Secondly, could you help us sizing the demand pull-forward effect from increasing prices in Q3 versus Q4? Normally, to what extent did that provided tailwinds to that civil aftermarket services growth in the quarter?

On the pricing, remember that in '22, we upped pricing on the catalog list price for CFM56 spare parts by a bit more than 10% on the 1st of November. And this year, in '23, we decided to pull forward to the 1st of August, the price escalation in the high single digit. It has exactly the same economic impact on a full year basis in terms of revenue. Do we expect to change for '24? The answer is no. What you would expect is, again, a price escalation on the 1st of August going forward, okay? Now with respect to your second question, what I could say is that pulling forward the escalation provided a boost to our Q3 sales, which are up, for sure, sequentially by 24% when you look to the civil aftermarket revenue growth. It was also strongly up when you compare to Q3 2019. Now when we move to Q4 this year, I would expect a quarter up maybe in the high teens year-over-year. It would be down sequentially because we did the price escalation in Q3 and not in Q4. And last year, it was done in Q4. So there is an unfavorable comparison base. And if I was to compare to Q4 2019, I would say it's rather flat.

If I could follow up on the first question again, which is very interesting. Would you be open -- just in an entirely theoretical sense, and of course, I'm not asking you what you're actually going to do. But in -- would you be comfortable with the kind of showing a double-digit price increase? Or do you think the sticker shock effect for your customers would be too painful? Maybe you can ask that in general terms rather than precisely as to what you're expecting next year.

Yes, it's too early to comment on that. But basically, we want to make sure that whatever price increase we decide, there's a rationale behind it. We don't want to be abusive or to appear to be, perceived to be abusive. There needs to be a rationale behind it. And if you look at what happened in the last years, even before the pandemic, we've always been above inflation by 3 to 4 points. That's what we've been doing. And so we'll continue on that path, I would say, at least for some years. So what's going to be the inflation next year? I don't know. I don't know. It's too early to say.

We'll now take our next question. This is from the line of David Perry from JPMorgan.

I've got three questions, if that's not too greedy, please. First, just on the very strong aftermarket print for civil aero engines. Can you just say, is any of that coming from the 0 margin LEAP work? Is that possibly why you didn't raise guidance? Second question is, at the start of the year, Pascal, you gave a very helpful and detailed bridge in terms of positive and negatives for this year. Inflation, I think, at the time, was EUR 700 million headwind. And I'm not sure you changed that, but I'm just wondering if you had any update on that? And then the last one was any chance you could give us -- any early thinking about the hedge rates you might be able to achieve in those outer years, I'm thinking '27, '28?

On civil aftermarket, it's true, and I said it during the presentation that there is a growing share of services revenue into our civil aftermarket's revenue. And part of that is coming from growing LEAP RPFH contracts, which by construction is coming with no margin at this point in time. So it has a dilutive effect, if you want, on the overall EBIT margin. I'm not saying this is the reason why we don't raise the guidance. Once again, we feel comfortable with the guidance and to deliver on the raised guidance we put out in the market in July. Inflation, very good question. At the beginning of the year, our estimate for inflation was around EUR 700 million, representing more or less 3 points of sales. Today, looking at the trends, I would say that we see some ease in energy. We see some ease as well in the transportation cost, logistics, but we see worse inflation coming from raw materials. All in all, inflation in 2023 should now represent 4 points of sales. So in euro terms, my expectation this year is about EUR 900 million to EUR 950 million of headwind. The good news is, is that we are managing or doing well to manage inflation. Again, this is not a reason why we don't raise the guidance. We know that since a couple of months that inflation will be higher, but we have ways, and civil aftermarket is part of the answer, FX as well. Now on your third question on FX. What we will do is to refine our FX assumptions in terms of hedge rate next February when we publish our full year results, and we will provide a number for '24 and a range for 2027.

Can I just -- one follow-up, if I may. These LEAP aftermarket sales this year, it's kind of -- I know it's a very small number, but is it $250 million? Is it $500 million? Something just to help us sort of gauge its impact would be helpful.

It starts to be material. It was really marginal last year. It starts to be material. And it will be even more material in the years for sure. But as you know, we don't provide any detailed number on that.

We'll now take the next question. And this is from Victor Allard from Goldman Sachs.

So actually, I have a couple of follow-ups to the prior ones, which have been addressed. The first one, if I may, is how to think about 3Q, 4Q in civil aftermarket and to which extent if at all? You've seen some pronounced level of prebuy in 3Q because I believe we heard from your partner earlier that -- it doesn't seem much on their side in 3Q. So I was wondering if it was like a similar reading on your side. And the second question is also like how to think about recent GE commentary regarding the LEAP profitability outlook. And I believe that they recently mentioned that they were expecting the aftermarket to be profit-making next year. I know you have taken this approach of not recognizing profit on those RPFH contracts as you just mentioned. But I was curious, if at some moment, you think you will be in a position to give color on how the underlying profitability of these contracts are tracking? Or -- so yes, that would be helpful.

Okay. On your first question, I've mentioned the favorable combo of volume, pricing and work scope to explain the very strong performance of civil aftermarket in Q3. I did not mention the pre-CLP or prebuy effect because we have the incremental benefits of the price increase, but we didn't see such a strong prebuy, as we call it, effect in Q3. So pre-CLP, I would say, almost no. On your second question, we can't speak for GE because as you know, within CFM, we are sharing revenue but not cost. So I don't know what is the profitability of GE with LEAP, and they don't know what is our profitability. What we said at the Capital Market Day back in December '21 is that we were aiming to reach breakeven on the OE side in 2025. I've mentioned in July that for 2023, we are already at breakeven due to the fact that there is a favorable mix between spare engines with respect to installed engines. We are working on cost reduction actions to go to our ambition to be at breakeven. And I would say, so far, so good. We see a path to achieving that target by 2025. On aftermarket, as you may have mentioned -- in the press release, we anticipate to have a Capital Market Day in Q4 next year. This will be the right timing to discuss into details what will be profitability with respect to the RPFH contracts for the LEAP, the LEAP spare parts going forward as well.

We'll now take the next question. This is from the line of Chloe Lemarie from Jefferies.

I have two, if I may. The first one is actually on Q4 for civil aftermarket. Your guide obviously implies a drop in the momentum in Q4, when Q4 last year was quite low already in terms of momentum. So could you explain what are the drivers for the slight slowdown that you expect for Q4? And the second one is on the AOG scandal. I was wondering if you could comment on the most recent assessment for 145 engines affected, if this is final? And how long do you see the shop visit to remove those parts taking at this point?