Feb. 7, 2023, © Leeham News: Our report last week about Rolls-Royce’s new CEO characterizing the company in dire straits is just part of the story. Shortly before that, on January 18, JP Morgan issued a 38-page dissection of the company that perfectly encapsulates what LNA has pointed out in the past about its commercial engine business.
JP Morgan looks at the entire company, while LNA focuses only on commercial engines. I’ll excerpt key points from JP Morgan’s engine section here.
Engine makers, RR included, don’t make money selling their engines. They make money on the parts and Maintenance, Repair and Overhaul (MRO) contracts. Or at least they used to. This business model has been increasingly under stress.
OEMs sold their engines at steep, steep discounts—up to 80% and in some cases, literally gave them to the buyer—in return for Long Term Service Agreements (LTSA). These covered MRO and parts purchases under long-term contracts. Accordingly, it takes the OEMs 10-20 years to recover development and sales costs.
But the reliability of previous generation engines, while a major selling point, became a double-edged sword. The very reliability meant fewer engine shop visits. Hence, revenues and profits began to fall at a slow, drip-drip-drip pace. The CFM-56 engine could go as much as 25,000 hours on wing, an astounding number. RR’s own Trent 700 on the A330 was good for around seven years on-wing before requiring a major overhaul.
But today’s engines are anything but as good in this regard. The problems with the RR Trent 1000 are well known. At one point, around 50 787s were on the ground due to failures in the 1000. Overwater operations were significantly reduced to flying near airports that could be used in an emergency.
CFM’s LEAP engine (the successor to the CFM-56) and Pratt & Whitney’s Geared TurboFan (the successor to the V2500) entered service in 2017 and 2016, respectively. There are reliability and durability issues with both. On-wing time hovers in the +/- 6,000 hour range.
The warranty work is hurting profits at the engine OEMs and causing executives to rethink how these are structured. There’s been some discussion about selling the engines for a more reasonable discount than historically.
JP Morgan sees RR’s LTSAs producing fewer profits going forward. “We are increasingly concerned that RR may have mispriced its long-term service agreements (LTSAs) and that the future profit on these contracts will disappoint, for two reasons. First, the costs to maintain its engines are likely to be higher than expected when it priced many of the LTSAs. Second, we see challenges with RR being able to fully pass on all of its cost inflation on LTSAs to its customers,” JP Morgan writes. And RR has higher exposure to LTSAs than its competitors.
All-in-all, the outlook is dismal for RR and challenging for GE and PW. A major makeover in the overarching business model is needed.