General Electric: A Detailed Cash Flow Analysis
- GE stock price has risen in recent weeks due to reports of accelerated asset sales.
- Asset sales alone likely won't be a panacea, due to a lack of cash flow at the enterprise level.
- A detailed analysis of cash flow casts serious concerns over the viability of GE's turnaround without an equity raise or significant recovery in energy prices.
Recent Optimism in General Electric Stock
After 2018 saw General Electric (NYSE:GE) stock price fall 57%, 2019 is off to a good start, with the stock up 8.6% so far versus 1.7% for the S&P 500 (SPY). What is the cause for optimism? Over the past few weeks, several headlines have rumored possible deals that could help GE monetize its assets and reduce its debt load.
First came the news in November that GE would accelerate plans to sell Baker Hughes (BHGE) and raise $4 billion through an equity issuance. Then, it was reported in December that the company had filed for the IPO of its Healthcare division. Finally, last week it was rumored that GE could sell its aircraft leasing unit for as much as $40 billion.
This flurry of news, along with a sub-$7 share price, caused GE’s most prominent bear, J.P. Morgan’s Steve Tusa, to upgrade the stock from Sell to Neutral. The share price has rallied over 20% since the analyst upgrade. Despite the upgrade, Tusa has noted that asset sales alone will not be enough to cover net liabilities (including an unfunded pension) of approximately $107 billion. Tusa and many investors share the belief that GE will need a massive equity raise in 2019 to right the ship.
The key issue at GE is that it has significant liabilities to service over the short, medium, and long term, but has no cash flow at the company level. Let’s take a closer look at the numbers, first at the enterprise level and then at the segment level.
Enterprise-Level Cash Flow Analysis
I recently wrote a detailed article explaining how the company got to this point. If you are unfamiliar with the struggles at GE, I recommend you read that explainer first. In this article, I will focus on the numbers.
GE has always been active on the deal front. As you can see at the bottom of the above table, it has made tens of billions of acquisitions and divestitures over the past 8 years. Coming out of the 2008 recession, GE made several adjustments to its portfolio. Then, CEO Jeff Immelt wanted to focus the company on industrial goods and away from financial services and entertainment.
To call out some of the larger divestitures: In 2011, GE sold a stake in NBC to Comcast (CMCSA) and sold the remaining stake in 2013. In 2015, it sold the Australian and Japanese arms of GE Capital. In 2016, GE sold its consumer appliance business.
At the same time GE was selling assets deemed to be outside of its Industrial vision, the company made acquisitions in the energy and power space. Most notably, it acquired Alstom in 2015 and Baker Hughes in 2017. These deals were consummated with significant leverage and right before large declines in the energy and power industries. If it were not for these two acquisitions specifically, GE would not be in as great of a liquidity crunch as it is today.
The other major capital allocation mistake made (in hindsight) was the massive stock buybacks in 2016 and 2017, which sum to nearly $24 billion. Buybacks, of course, were financed with cheap debt. However, the debt GE accumulated at low interest rates will need to be re-financed at much higher interest rates now that the company is considered a credit risk.
As we can see from the above table, 2017 is when things came to a head. Energy and power, which together accounted for over 42% of 2017 revenue, experienced significant declines and created large operating losses for the entire company.
Free cash flow remained positive in 2017 but quickly deteriorated. Over the last 12 months, the overall company has been free cash flow-negative and will continue to burn cash for the foreseeable future due to continued difficult operating environments in the energy and power segments.
When Larry Culp became CEO in October 2018, one of the first actions he took was to cut the dividend to a penny. Based on the cash flow analysis and what we know about the balance sheet, this move was very prudent.
Mr. Culp then pledged to accelerate a break-up of the company. Based on the headlines that have crossed over the past 2 months, it appears that Culp is executing well on this. Asset sales can buy GE time to stave off its liability situation; however, the company needs to see a recovery in its operating businesses to make the transformed enterprise sustainable.
Segment-Level Cash Flow Analysis
I used the segment disclosure in the company's 2017 10-K to create the below table. I took segment EBIT, added segment D&A, and reduced by segment capex. These figures exclude taxes, interest expense, and corporate overhead (aka a lot of other necessary expenses). The analysis ended at 2017 because we only get cash flow detail in the 10-Ks, and the 2018 10-K has not yet been released.
There is roughly $10 billion in additional corporate overhead, interest, and taxes. However, much of the true cost of the conglomerate structure is already baked into the segment numbers. J.P. Morgan analyst Stephen Tusa has estimated as much as $38.9 billion in total annual corporate overhead expenses. As I noted in my prior analysis, this “conglomerate tax” is quite burdensome and doesn’t seem to have created much value. Rather, the conglomerate structure appears to have incentivized prior CEOs to engage in empire building.
The segment cash flow analysis very quickly exposes the problem segments. Power saw its cash flow decline over $2.5 billion in 2017. Oil & Gas is hemorrhaging significant cash. Lighting is a melting ice cube. Finally, GE Capital has been a huge cash flow drain. Aviation and Healthcare have been the clear bright spots, although Healthcare will be separated soon, as will Transportation.
Digging further into the underlying issues, Power and Energy are performing poorly due to industry-wide issues that are out of GE’s control. The company is aggressively cutting costs and preserving cash flow; however, these segments will need a sea change in energy prices to perform at their potential. This is why Culp is focused on monetizing segments like Healthcare and Transportation that are not facing acute short-term headwinds.
Although we don’t have cash flow details at the segment level for 2018, we have operating profit as shown in the below table. The large problem segments Power, Energy, and Capital showed continued deterioration. The below segment profit figures are before capital expenditures, corporate overhead, interest, and taxes.
(Source: General Electric Q3 2018 10-Q)
The outlook for these problem segments is poor.
In the recent 10-Q, the company noted that the outlook for Power has deteriorated further due to overcapacity in the industry, market share losses, and the slowdown in emerging market economies, which represent a large share of the customer base. Furthermore, competition from renewable energy has arrived and has significantly hurt demand for GE’s fossil fuel-based energy solutions.
The energy segment has been negatively affected by the price of crude oil, which has recently taken a leg lower from already depressed prices.
Finally, GE Capital continues to bleed money due to its position as the financier of various insurance programs, warranties, and a mishmash of miscellaneous liabilities. The truth is that GE Capital is still very much a complex black box. It has been reported that the segment has suffered from years of accounting shenanigans to aggressively finance customers and smooth quarterly earnings. These questions over accounting have attracted regulatory attention, and now both the DOJ and the SEC have ongoing investigations into the business and accounting practices that have taken place at GE Capital.
Recent news of impending asset sales and deleveraging events has triggered some optimism in the shares of GE. Although the prospect of offloading tens of billions in liabilities will buy time, the only thing that will save GE at the end of the day is positive free cash flow. Unfortunately, it seems that the primary drivers of free cash flow generation may be out of the company’s control. If demand in the power and energy markets does not pick up, GE may not be able to execute a turnaround.
The other ace in the hole could be a massive equity raise or rescue financing from the likes of Berkshire Hathaway (BRK.A, BRK.B). Asset sales in 2019 could be enough to lift GE share price and investor confidence to the point where it can issue equity at attractive prices.
As an individual equity investor, these risks are incredibly difficult to discount. I do not like the prospect of investing in companies that do not have control over their own destiny. Larry Culp appears to be an incredible leader, and I do believe if anyone can pull this off, it is him. However, I am inclined to continue watching GE from the sidelines until the situation de-risks or I have a better indication that the cash flow issues at the business operating level have improved.
Reader note: This is a continuation in my series covering General Electric. To read my article detailing the company's turnaround effort, click here. To read my article comparing General Electric's debt load to AT&T (T), click here.
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