GE: Larry Culp's 'Report Card'

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About: General Electric (GE)
by: James Coleman

Summary

At GE's 3rd Quarter 2018 Earnings Webcast on October 30, 2018, the company announced the following:

GAAP continuing EPS of ($2.63); 3Q '18 adjusted EPS (non-GAAP) of $0.14 (a 33 1/3% decrease from consensus of $0.21).

A goodwill impairment charge of $22 billion, before tax, related to GE Power.

Reduction of the quarterly dividend to $0.01 per share.

Investment Thesis

The irrational exuberance of H. Lawrence (Larry) Culp, Jr. being named GE (NYSE:GE) CEO on October 1, 2018 was clearly evident as GE’s stock surged more than 20% within a week of his appointment.

However, since the reality has set in that atmospherically GE is fundamentally flawed, the stock has plummeted to $10.10 on volume much greater than the 90 day average.

The purpose of this article is to present and review the following author’s “report card” of GE’s new CEO as a basis for further evaluation of Mr. Culp’s performance going forward.

Based on my review of GE's most recent 10-Q, I currently rate the stock as a "hold."

The author considers it problematic that GE did not provide any updated guidance regarding 2018 EPS and cash flow metrics and therefore he is unable to make an informed judgement regarding whether the company is worthy of investment at this time.

Readers of this article are encouraged to use the above template to develop their own “report card” of Mr. Culp’s performance at his first GE conference call in order to help them evaluate the merits of being a GE shareholder, either now or going forward.

The author invites any and all comments about this article in an effort to gain substantive feedback in this regard.

Recent Developments

On October 1, 2018, GE announced that H. Lawrence (Larry) Culp, Jr. would replace John Flannery as CEO effective September 30, 2018. Flannery, who had been in that position for a little more than a year was ostensibly terminated because of his inability to act in a timely manner regarding GE’s serious financial and operational issues.

Mr. Culp, who had been a member of GE’s Board of Directors since April 2018 has a summa cum laude resume as the former CEO of Danaher Corporation (NYSE: DHR)

He is the first non-GE (“outsider”) CEO in the company’s 126-year history and much is expected of him as GE has clearly underperformed in 2018, and the prior several years. GE’s current stock price is down more than 60% since the departure of former GE CEO Jeffrey Immelt in June 2017 and was trading at $10.10 when this article was submitted for publication.

Larry Culp's "Report Card"

This "report card" is based on my listening to GE's 3rd quarter earnings webcast (the logistics of which were woefully lacking in clarity and volume) and the transcript of the analysts' Q&A session.

Presenter: H. Lawrence (Larry) Culp, Jr., CEO

*Metrics

A

B

C

D

F

Goodwill Impairment

X

Debt

X

Divestitures

X

Headcount Reductions

X

*Adapted from a 10/29/18 article by Greg Ryan, Boston Business Journal

Caveat: Mr. Culp was given a “Pass” regarding his lack of attention to HQ and related corporate issues and his appalling lack of knowledge about the Boston Red Sox.

Grading Scale:

A Excellent 4.0, B Satisfactory 3.0, C Needs Improvement 2.0, D Unsatisfactory 1.0, Fail 0.0

GPA: 3.0

Readers of this article are encouraged to use the above template to develop their own “report card” of Mr. Culp’s performance at his first GE earnings webcast in order to help them evaluate the merits of being a GE shareholder, either now or going forward.

The author invites any and all comments about this article in an effort to gain substantive feedback in this regard.

Timeline of GE’s 2018 YTD Deteriorating Cash Flow

As recently as July 2018, GE had forecast “about $6 billion” in adjusted free cash flow for 2018, down from $9.7 billion in 2017 and $11.6 billion in 2016.

However, the company has since trimmed back its forecast, and has not provided any updated guidance in this regard.

Based on the author's review of GE's most recent 10-Q, which was filed with the SEC. it appears that 2018 cash flow will be at least ~40% less than 2017.

This code blue situation needs to be immediately addressed by Mr. Culp, as GE’s credit rating is in danger of being further downgraded by the “Big Three” credit rating agencies, which would increase the company’s borrowing costs at a critical time in their history.

In the author’s view, the company’s disclosure that both the SEC and DOJ have expanded their probes of GE’s accounting practices adds more immediacy and importance to this issue.

Goodwill Impairment

At the 3rd quarter 2018 earnings webcast on October 30, 2018, GE provided clarity regarding their October 1, 2018 disclosure regarding the goodwill impairment charge, which was the major factor in GE Power reporting a quarterly loss.

The absolutely mind-boggling enormity of the amount, which is more than 12 times bigger than the highest impairment charge of 2016 according to Duff & Phelps had an immediate and profound effect on the company’s financial statements. GE’s statement of financial position (a/k/a balance sheet) reflects this asset decrease and weaken the credit metrics which have been the subject of scrutiny by long-time GE “bear” Steve Tusa of JP Morgan.

GE's Debt Is A Rising Concern For The "Big Three" Credit Agencies

The complexity and magnitude of GE’s debt is beyond the scope of this article but in the author’s view, Mr. Culp’s bold step to reduce the dividend by 90+% was appropriate given the financial constraints of the company. However, it is quite likely that GE’s large retail base may not embrace this move, and hence the company’s stock price may be adversely affected.

Given the high level of concern expressed by GE CFO Jamie Miller regarding GE Capital’s eroding financial stability, and the continued worsening performance of GE Power, it is incumbent on GE CEO Larry Culp to promptly and proactively address this critical issue.

The author cannot overstate that time is of the essence in this regard, as there is an imminent threat of a credit downgrade based on GE's financials.

Divestitures

Former GE CEO John Flannery had announced plans to spin-off GE Healthcare in 2018 (after saying on November 13, 2017 that it was a “core” holding) and also to dispose of BHGE in “2-3 years.”

Mr. Culp’s “initial observations” did not provide any change to these plans and there is speculation that there may be a change to the timeline of these issues. In the author's view, GE needs to inform all its stakeholders about these matters as soon as possible.

Additionally, it is incumbent on GE to weigh in on whether the recently announced criminal investigation by government regulators may affect the status of any/all planned divestitures.

This actionable item is of high priority, and further obfuscates an already muddled situation regarding GE's financial reporting policies and practices.

Headcount Reductions

GE’s move to Boston in 2016 was heralded by several divergent constituencies - businesses, educators, politicians et al - and the company was granted significant tax and other concessions in that regard.

However, given the erosion of the company’s fortunes, it appears to many observers (the author included) that GE may very well need to change its plans.

To date, Mr. Culp has not addressed this critical issue, and has not shared any insights to the status of headcount reductions at GE Power and Corporate HQ.

In the author's view, this lack of communication is troubling and needs attention as soon as practical, especially since GE has clearly stated that this issue is an integral part of the company's 2018 cost out plan to “right size” the company.

Conclusion

As the narrative above indicates, in the author’s view, Mr.Culp did a commendable job of addressing the issues discussed herein. It is abundantly clear that he has more than a “heavy lift” in order to achieve his stated goal. The rhetoric regarding how his recent site visits contributed to his appreciation for GE’s 300,000 employees and their dedication to the good of the company hopefully will translate to a better company in the foreseeable future.

However, given the critical financial and operational headwinds facing the company, GE's lack of transparency clearly means that it is not possible to make an informed decision about the merit (or lack thereof) of being a GE shareholder.

Adh mór Mr. Culp.

Disclosure: I am/we are long GE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.