Two quality European multinational companies trading at attractive valuations

MTU’s core technology is its high-speed low-pressure turbine. Its aerodynamic optimisation enables it to achieve higher efficiencies than competing turbines. They focus on the narrow body aircraft market and are part of a number of engine consortiums. They have an 18% share of the GTF engine with Pratt and Whitney holding the largest stake in the consortium. The GTF engine has a 40% share of airbus aircraft, higher than its major competitor, the Leap engine. Their only major competitor is CFM International, which is a JV between GE and Safran, that produces the LEAP engine.

What sets the GTF propulsion system apart is that it features a reduction gearbox between the fan and low-pressure shaft on which the low-pressure compressor and low-pressure turbine that drives the fan are seated. This increases efficiency and reduces carbon dioxide emissions by 16 percent. By 2030, CO2 emission will be cut by approx. 25 percent and the noise level further reduced as a result of continued optimisation. Its fuel efficiency advantage is what makes it an attractive choice for aircraft manufacturers like Airbus (EPA: AIR).

The sale of engines is a multi-year process, whereby the engine manufacturers generate most of their profits after a period of time during the maintenance and service phase of the fleet. MTU generates 800 million euro in earnings before interest and tax with the GTF engine only generating about 100 million of this. Their V2500 engine is their most profitable engine at the moment. The consortium that MTU is part of that produces the V2500 engine first started selling these engines in 1989. Over 7600 of these engines were delivered over the next 30 years and now the consortium generates significant profits from maintaining and servicing these engines.

MTU has recently seen its stock fall over 20% due to Pratt and Whitney’s decision to service and check 700 aircraft with GTF engines produced between 2015-2021. There is concern about a faulty component, but not one of MTU’s parts. Pratt and Whitney announced a $6-$7 billion provision as a cost to ground these planes and check the engines. Whilst MTU’s share of the consortium is only 18%, its market capitalisation has fallen more than its share of the costs. Further, after meeting Airbus in Europe, it is clear to us that Airbus has no intention of cancelling its current intake of GTF engines for 2023 and 2024. Airbus can’t keep up with the current demand for narrow body planes from airlines. They also are confident that there is nothing wrong with the current GTF engines being produced.

I have been following and meeting the engine manufacturers for over a decade and have visited MTU’s manufacturing centre just outside of Munich. It is very rare to be able to buy such a high-quality business at such an attractive valuation and we have been taking advantage of the fear in the market to accumulate shares. I also met with MTU management in Munich in September, and they seem confident that the estimated costs to inspect the old engines are conservative.