MTU Aero Engines downgraded by Citi amid slower growth, weaker cash conversion

Investing.com -- Analysts at Citi Research in a note dated Monday have downgraded MTU Aero Engines. (ETR:MTXGn) to “sell" from "neutral." 

This downgrade is based on Citi's detailed financial analysis and projections of MTU's future performance, which suggest a slower growth trajectory in comparison to its peers in the aerospace industry. 

The downgrade reflects concerns over normalizing profit growth rates, weaker cash conversion metrics, and a relatively expensive valuation when considering longer-term prospects​.

Citi analysts forecast MTU Aero Engines to achieve an average profit growth of around 8% CAGR from 2024 to 2029. 

This is lower than many of MTU's aerospace competitors, such as Rolls-Royce (LON:RR), Safran (EPA:SAF) and Airbus (EPA:AIR), which are still seeing a post-COVID recovery with higher growth rates.

MTU is recognized as one of the first aerospace companies to recover from the pandemic, but this rapid recovery has led to a normalization of its growth potential. 

“While we are expecting continued strong recovery in 2024 (16% sales growth and 20% profit growth vs 2023), we expect growth from 2024 to be more normal (3-4% ASK growth, plus 3-4% pricing),” the analysts said.

A key issue driving the downgrade is MTU's lower cash conversion rate, which Citi estimates will reach only 82% in the medium term. 

This is significantly below the cash conversion rates of its peers, such as Rolls-Royce (OTC:RYCEY) (120%), Safran (100%), and Airbus (93%)​. 

Despite Citi assuming that MTU's cash conversion could improve to 90% in the long term, this metric still lags behind the industry's top performers, limiting MTU's valuation appeal​.

Citi's DCF (discounted cash flow) analysis led to a valuation of MTU at an EV/EBIT multiple of 15.4x for 2024, which is in line with its aerospace peers. 

However, due to lower growth and cash conversion, MTU's projected fair value is considered less favorable, leading to the €250 price target​.

MTU is priced at a premium compared to peers when looking beyond 2024. Citi also flags several factors that could influence MTU's valuation, including sensitivities to commercial spares growth, margins in its OEM and MRO segments, and foreign exchange rates. 

For example, if the EUR/USD rate moves to 1.20, it could further reduce MTU's fair value by €22. Conversely, improving spares growth and margins could drive the stock's fair value up to €300, though such scenarios are considered less likely​.