European Aerospace OEMs: Materially Increasing Our Fair Value Estimates; Safran Is Most Attractive

After taking a fresh look at Safran, MTU Aero Engines, and Rolls-Royce RR, we have confirmed our economic moat ratings but materially increased our fair value estimates to account for a post-COVID-19 air traffic recovery in civil aerospace and pent-up demand in the original equipment segment and aftermarket.

Of these three European aerospace original equipment manufacturers, we believe wide-moat Safran is a clear winner, thanks to its position in the narrow-body aircraft market and proven reliability of its engines. The shares appear compelling, trading at a 25% discount to our fair value estimate.

During the pandemic, 50% of flights were grounded; airlines focused on cost reductions by canceling or deferring orders and pushing aftermarket activity as far out as possible to preserve cash. The industry has shown considerable resilience, as we have seen a consistent demand recovery in available seat kilometers, primarily driven by leisure travel, demand for narrow-body planes, and China’s reopening.

The positive outlook for narrow bodies is supported by the growth in the middle class and point-to-point travel and replacement momentum, as over 20% of the global fleet is more than 20 years old. We expect an increase in narrow-body production with over 26,000 deliveries during 2022-35. This is a significant opportunity for Safran and MTU, given their emphasis on the narrow-body segment.

While narrow-body aircraft demand is leading the recovery, there are also signs of improvement in the wide-body segment, albeit at a slower rate. We project approximately 5,000 wide-body deliveries in total from 2022 to 2035, with Rolls-Royce expected to capture approximately 2,700 new deliveries as it powers all four of its new wide-body planes into service, with three sole-source positions for Airbus.