“The sky is not the limit, it’s just the beginning!”
– Anonymous
arvy’s teaser: Safran, not the spice but the French industry leader, stands out in an oligopolistic market characterized by high barriers to entry and strong pricing power. Its strategic positioning and two-pillar business model make it a solid contender for long-term compounding. Add to this a sizeable growth driver for decades – space.
Aerospace.
It has always been an area that has fascinated me.
Not only because of one of the best movies of all time “Catch Me If You Can” with Leonardo DiCaprio in the role of the famous check fraudster who pretended to be a Pan Am pilot, but also because I come from a family that has been in this business for decades.
That gave me a pretty good understanding of the industry from the beginning, and when I was able to make the connection to investing, I realized there were a lot of things to like. I agree with you that it is not the first thought of many because they think of airlines first. And we all know, to give you a second great movie to watch again, what Gordon Gekko said about them in the 1987 classic “Wall Street”: “I don’t like airlines, they’re lousy unions.”
What I am talking about are the companies that build and deliver the airplanes.
In particular, a French global market leader.
Safran.
Chart 1: Safran’s five core businesses (Propulsion, Equipment, Interiors, Defense & Space)
Source: Safran, annual report 2024
Oligopolistic market
Safran is a leading global aerospace supplier specializing in engines, equipment and interiors for commercial aircraft (chart 1).
Due to the very high barriers to entry, there are only five main players:
- Safran
- Rolls-Royce
- MTU Aero Engines
- General Electric (GE Aviation)
- Pratt & Whitney, owned by RTX Corporation (merger of Raytheon & United Tech)
They often even form joint ventures to reduce the workload and complexity. One example is CFM International, a joint venture between Safran and GE. They manufacture the engines for the Airbus 320 Family (60% market share, 40% Pratt & Whitney) and the Boeing 737 (100% market share, exclusivity due to the difficulty of lower wings) – the two best-selling airplanes in the world (chart 2).
Fun fact: How can you tell the difference between a Boeing and an Airbus? Check out the nose: Boeing has a pointed nose, Airbus has a blunt nose.
Just last summer IndiGo, India’s largest airline, placed a record order of 500 Airbus A320 for a total order of 1’330 planes to be delivered. Let’s do the math: 1’330 * 2 = 2’660 engines just for India.
The combination of all these factors puts Safran in an oligopolistic market structure.
Characteristics such as these arouse my interest.
Chart 2: Boeing 737 vs. Airbus A320, both with CFM engines
Source: BAA Training
Fend off competition
Oligopolistic markets are attractive. But why?
Firstly, in most cases the companies in these markets have a wide moat. This means that they can fend off competition, have high profit margins, a strong cash flow and can reinvest their capital at high returns.
Secondly, market share gains. Companies cannot always beat every competitor, which leads them to target weaker competitors and avoid stronger ones. They repeatedly take market share from weaker competitors. The oligopoly (or duopoly) becomes even stronger.
This all leads them to the third, very important long-term factor, the compound interest effect. High-quality companies gain market share, reinvest capital at high returns, and benefit from the compound interest effect. Despite appearing highly valued in the present, market participants have difficulties efficiently pricing oligopolies, therefore offering opportunities for active managers.
The sum of all these points makes them solid candidates for compounders.
And in the case of Safran (chart 3), that is not all.
Chart 3: Safran over 10 years
Source: TradingView
Two-pillar business model with a sizeable growth market
Safran is excellently positioned.
The French government owns 11% of the company. And the largest aircraft manufacturer in the world, Airbus, which is taking big market shares from Boeing, is also a French company.
You get my point.
This applies to the first pillar of the company: the company has a 70% share of the global market for narrowbody planes (single-aisle aircraft, 100-220 passengers) and has an order backlog of more than 10,000 engines. The company is heading for a production level of over 2,000 engines per year to fulfill the order backlog. Added to this are interiors and equipment.
This brings us to the second pillar, maintenance and the spare parts market: for every engine sold, there is a spare parts market and a maintenance market for which Safran has concluded a contract with a term of 8 to 25 years – remember IndiGo. This provides visibility and stability for business success, underpinned by high service margins. More than 40,000 engines are subject to such contracts at present.
In summary, it is an attractive and steadily growing aviation market. And now there is a sizable upside opportunity in a newly established growth market.
I talk about the race for the lead beyond the earth that has just started, after all “The sky is not the limit, it’s just the beginning”.
We talk about the future of geography (chart 4).
Space.
Chart 4: arvy’s Book Club – Future of Geography
Source: arvy’s Book Club
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