General Electric: NewCo Remains A Disaster
Summary
- GE reported another poor quarter for NewCo.
- NewCo's Q4 revenue was flat Y/Y, but segment profits fell by over 40%.
- Power's operations remain in disarray and GE Capital will create more cash burn this year.
- As long as the rating agencies do not downgrade GE again then investors can speculate in the stock.
- GE remains a sell.
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GE flood lights. Source: Barron's
Heading in to Q4 earnings General Electric's (NYSE:GE) credit quality was cause for concern. After downgrading GE's down a few notches from junk status, the rating agencies expressed concern over the diminution of Power Systems. The company also named H. Larry Culp as new CEO. Culp has accelerated asset sales in order to pare debt and appease the rating agencies.
Revenue from core GE (NewCo) - Aviation, Power Systems and Renewable Energy - was $18.6 billion, flat Y/Y. This was an improvement over the high single-digit decline last quarter. Over 35% of NewCo's revenue comes from Power Systems, which remains a laggard.
Orders fell 19% Y/Y as the operating environment for Power continues to deteriorate. Overcapacity in the segment persists, as well as lower demand for equipment. Long-term, the 25 to 30 gigawatt market will drive the Power segment. Management is adjusting to this trend. Revenue fell 25% and will likely fall in 2019 due to waning demand and pricing pressure.
Aviation orders were up 12% and the segment's performance were stellar again. Equipment orders grew 20%, driven by strong momentum of the LEAP engine program. Military equipment orders were up 69%. Aviation revenue was up 21%, and remains the stalwart of NewCo. President Trump has cited a need to beef up military spending, and this could remain a catalyst. At some point, the slowing economy could impact commercial orders or sentiment for the Aviation segment. For now, Aviation remains a star.
Renewable Energy orders were up 19%, driven by onshore wind equipment orders (up 9%) and service orders (up 32%) on strong repower units. Revenue rose 28%, which followed a 15% increase last quarter. The repower backlog is encouraging and the continued disruption of the overall Power segment should drive revenue growth in 2019 and beyond.
Total revenue growth for NewCo was flat Y/Y. For any other company this would likely be considered dismal. This could be considered a win for GE given that NewCo's sales have been falling by high single-digits. I believe we are at peak economy and the company could face headwinds going forward.
Segment Profit Continues To Fall
GE's overall operations have been noisy over the past few years. Constant buying and selling of assets and restructuring efforts have made it operations opaque. This quarter was no different. Management continues to rightsize Power, so NewCo's pure earnings power remain difficult to ascertain. Segment profit for NewCo was $918 million, down over 40% Y/Y. Power had segment profit of -$872 million; the loss included a few hundred million of charges related to restructuring and gas Power Systems projects. Segment profits for Aviation and Renewable Energy were $1.7 billion and $67 million, respectively.
Segment profit margins for Aviation were practically flat. Margins for Renewable Energy were 2%, down from 5% in the year earlier period. Blended margins for Power and Renewable Energy continue to decline, which implies the segments are running in quicksand. It could take a year or more for the company to iron out these structural issues. Power and Renewable Energy could drag down segment profits for the foreseeable future.
Cash Flow Remains Problematic
On the earnings call management talked up the sale of Transportation to Wabtec (WAB), the pending sale of Healthcare and continued pare down of GE's Baker Hughes (BHGE) stake. The sale of GE Capital Aviation Services (GECAS) is currently off the table. That said, asset sales will allow the company to pare its $110 billion debt load.
Total industrial free cash flow (FCF) during the quarter was $4.9 billion. This figure excludes GE Pension Plan contributions. FCF was buoyed by a $2.3 billion increase from working capital, which may not occur each quarter. Full year FCF was $4.5 billion; Power dragged down full-year FCF by about $2.7 billion. Management expects to contribute about $4 billion to GE Capital in 2019, which underscores the fact GE Capital remains a black hole. However, promises of asset sales may be enough to keep the rating agencies from downgrading GE's credit rating further.
Conclusion
In my opinion, this was another disastrous quarter for NewCo. GE was up by 15% in mid-morning trading. As long as the rating agencies do not downgrade GE's debt then investors can continue to engage in wild speculation on where the stock is headed. Based on earnings fundamentals, I rate GE a sell.
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