Safran

Safran is a great business whose share price has been cut in half.

Its "Fly-by-the-hour" and maintenance revenues make it partially a proxy for air travel.

Business

Safran is in the Aerospace industry, their 2019 segments are:

• Propulsion.  Building (OE), maintenance (MRO) and spare parts for jet engines.  Almost half of company revenue.  56% of their propulsion revenue is from services (maintenance and parts), the rest is from OE.
• Aircraft equipment, defence and aerosystems: 37% of company revenue.  1/3rd of this segment's revenue is from maintenance.
• Aircraft interiors: 9% of company revenue.  One quarter of this segment's revenue is from maintenance.  From the 2018 Zodiac acquisition.

The crown jewel is jet engines.  In the narrow body market, their CFM-56 engine (co-owned 50/50 with GE) is the world's best selling aircraft engine, on the back of secular LCC growth.  They look to continue this dominance as they transition the old CFM engines to the new LEAP, which will work on the Airbus, Boeing and Comac planes.

Their only competitors in narrow body are P&W, and possibly a Chinese supplier for Comac.

2/3rds of 2018's Propulsion revenue was from CFM. So around 1/3rd of company revenue.  Could not find a profit breakdown.

In the wide body market, Safran has been involved the GE90 through its 23.7% stake.  This revenue will fall, as it is replaced by the GE9X, in which they only have an 11% stake.

In the mid range market, they have an 8% stake in the GENX engine, used by the B787 Dreamliner.  This revenue will probably increase in future, as B787 sales continue.

They target different margins for the operating segments:

Contract Liabilities

This is the by far the company's largest liability.  What are they?

Prior to 2018, "Fly-by-the-hour" revenue was recorded when paid, and lumpy costs (eg: 5 year overhaul) were artificially smoothed out:

Source: Safran IFRS 15 workshop (p6) 

For 2018 onwards, with the adoption of IFRS 15, revenue is adjusted to follow the real costs:

Payments in advance (in excess of revenue) are recorded as contract liabilities, against the new cash (asset).  When the lumpy costs occur, they are charged, and the corresponding contract liabilities  are reduced (along with the cash used to pay for them).

Financials and Liquidity

How long can they last in the current crisis?  Without external funding.

Their balance sheet is passable.  Against an adjusted (p15) PBT of 3.7bn, net debt is around 4.6bn.  The main liability is 10.4bn of contract liabilities, we don't know how many years later they are due.

For the income statement:

• 25bn revenue, 21b costs, 4bn profit.  A 14% operating margin.
• Of the 21bn: 14bn of the costs are variable (6bn raw materials, 5bn subcontracting, and 2bn external services).  1.6bn is D&A - ignore it.   6bn are personnel costs, take them as fixed.  Interest cost is neglible.

Last week they announced:

• Net debt is has now decreased to 3.2bn
• Dividend is cancelled
• Cash is 3.1bn, of which 2.8bn is accessible within 90 days
• They have an undrawn 2.5bn revolving credit facility till end 2022.
• 2.8bn of debt is due this year, they are arranging a new 3bn credit line up to 2 years.  My guess is that this can be done, unless banks run out of money (everyone takes loans at once).  This is not a credit crisis like 2008.

In the worst case, I think this can last them at least 5 months.  Its a blind guess, no one knows how much things can choke up, from the airline customers to Boeing and GE, all the way down the supply chain to the company who makes the rivets.

Their finances are not as conservative as I'd like, a company with so many accrued contract liabilities should have more cash.  Still, leverage is low, and they are not as indebted as the typical US company.  A bit hard for me to make a decision, for three reasons:

• There's a possibility the covid crisis lasts more than 5 month.  Will be a while before people book holidays again.
• Many airlines will go bankrupt.  Demand for planes drops off a cliff.
• There may be supply issues along a complex supply chain.  If any one part fails (one company under lockdown), the whole aircraft is unfinished.  Its not like a Big Mac, where you can still make one without pickles or sesame seeds.

I am undecided.  They can probably make it through, but not sure.  I'm sure that if they ran into problems the French government (or even private investors) would finance them, but I would want to buy shares after it happens.

Risks

Longer term:

• Other countries may try to break the Boeing/Airbus duopoly on narrow bodies.
• I wonder if people will travel less as the world becomes less globalised.

Valuation

Doing it based on their peak (pre virus) 2018/2019 earnings for cashflows.

• On earnings, a price of EUR 90 is 22X 2018 earnings, and 15X 2019 earnings.
• On company calculated free cashflows (p24), a price of EUR 90 is 22X 2018 FCF and 20X 2019 FCF.

I would probably buy somewhere between 12X and 15X peak FCF.  Around EUR 49 to 68.

Conclusion

Great company.  Not sure if I would buy at current valuations.  They can probably survive a covid slowdown/lockdown without external funding, but not 100% sure.

I think the bear market is not over yet - one month is too short.  Later on, the stock price may be lower, and we may have a better idea about how well they can survive.

Misc

When reading company materials, they use the word "recurring" for any operating income.  This includes OE, it does not just mean services.

They don't seem to release detailed quarterly results, which will make it harder to track their financial position in a few months.  Track their press releases instead.

2018 had substantial contract liabilities added (p87), which will make the CFO seem better than it really is.  Not sure about 2019, as the detailed cashflow statement is not release yet.