General Electric: Falling To Rock Bottom

|
About: General Electric Company (GE), Includes: BHGE
by: Daniel Jones
Summary

According to a recent presentation provided by General Electric, 2019 is slated to be rock bottom for the firm most likely.

Free cash flows will be negative this year, or flat at best, as the firm ramps up its restructuring efforts.

Continued weakness in Power and Renewable Energy will negatively affect the firm and Aviation's bottom line should flatline.

2020, however, should set the stage for a real recovery and investors should bank on management's guidance for now.

2019 is shaping up to be a very interesting year for General Electric (GE) and the company's shareholders. According to a presentation released by the management team at the conglomerate, it looks as though the year will be more difficult than many (myself included) anticipated, but while this should prove to be a year of pain for investors, the business is taking the steps it deems necessary in order to turn the ship around. Assuming management's rather thorough accounting for the troubles of the company are accurate, this suggests that investors hoping to make a nice return on the firm in the near term may be left waiting for a while, but for those who fashion themselves long-term investors by nature, the picture looks set to only get better after this year.

Expect a rough 2019

It's no secret that the past couple of years now have been particularly rough on General Electric, but if the period of 2017 and 2018 could be considered bad years, 2019 should prove the crash from a fundamental perspective. Last year, the conglomerate generated industrial level cash flow of about $4.3 billion, but this year, the company expects this figure to range between $0 and -$2 billion. As you can see in the image below, this will be driven by a number of factors.

*Taken from General Electric

On one hand, we have continued pain in Power, but you also have negative free cash flow results anticipated for the company's Renewable Energy segment. The bulk of the pain, however, will come from supply chain transitions and various restructuring activities. On the whole, the company thinks that overall restructuring will cost between $2.4 billion and $2.7 billion for this year, with over $2 billion of that being in the form of cash expenses. Even though this will be painful, management anticipates reducing corporate free cash flow from -$1.2 billion last year to around $0.7 billion per annum by 2021. This can be chalked up to staff reductions and other related activities.

While this may seem like General Electric may need to raise cash, spurring fears of an equity issuance or a further cut to the distribution, both of these appear unlikely because of the cash generated from asset sales and other activities. According to management, the sale of the company's BioPharma operations, Baker Hughes, a GE Company (BHGE), and its merger of its Transportation segment into Wabtec (WAB) will result in cash proceeds between this year and next of about $38 billion. This, in turn, will allow the company to pay down $16 billion in debt associated with General Electric's Industrial operations and if my math is correct, net debt under these operations will fall from $55 billion last year to between $17 billion and $19 billion by the end of 2020.

On the side of GE Capital, the business is expected to bring in cash over this same timeframe of around $41 billion, with $12 billion of that being in the form of an intercompany loan paid back by the firm's Industrial operations. In all, $25 billion in debt should be reduced on the GE Capital side of the business, bringing leverage down to under 4 by next year, even as it pays its $1.5 billion WMC settlement and covers the $2 billion in annual insurance payments required of it. This compares to a net leverage ratio of less than 2.5 for the conglomerate's Industrial operations.

Expect pain in two key segments

As I alluded to already, the real pain for General Electric will come from not only its Power segment but also its Renewable Energy segment as well. On the Power side of the equation, the firm anticipates revenue to decline this year by the high-single digits and free cash flow will come in worse than the $2.7 billion outflow experienced in 2018 (though by how much management would not say). Revenue should begin increasing again in 2020, but free cash flow on this side will continue to be the real story for the foreseeable future.

*Taken from General Electric

These issues are driven by what management refers to as a new reality for the business. As you can see in the image above, back in 2015, there was demand for 56 GW (gigawatts) for its gas power technology. Due to industry oversupply, the foreseeable future will likely be a range of between 25 and 30 GW per annum, sharply lower than what the company needs in order to be free cash flow positive. One way management is hoping to reduce costs on this front is to reduce Power's number of headquarters from three locations to one, which alone will help to reduce rental payments between 2018 and 2020 by about $50 million. In a prior article, I discussed some of the issues affecting Renewable Energy, so I won't bore you with a rehash of that short case.

The one bright spot may not improve much

Over more than a year now, I have fawned over General Electric's Aviation segment. This has been due to attractive industry trends the segment can benefit from as well as a history of robust sales and segment profit growth. In management's presentation to investors, it was revealed that revenue should grow in the high single digit rate for this year, followed up by additional (though an unspecified rate of) growth next year. That said, the business said that free cash flow should be flat in 2019 at about the $4.2 billion it generated last year and that some growth on the bottom line may be possible in 2020.

With $211 billion in backlog, Aviation can be considered the true core of General Electric and investors who are bullish on the firm can and should consider Aviation to be what not only keep the company afloat but also can push it ahead in the years to come. The notion that cash flow may flatline, even as sales grow, suggests potential pricing pressure on the horizon and/or an unfavorable sales mix. While this in no way counters my own arguments in favor of Aviation being an integral and attractive part of the enterprise, it does imply that investors should be cognizant that the past that built up the segment may not point to ever-improving fundamentals in the years to come. In short, for the firm to truly grow in the long run, it will be incumbent on management to get the rest of the conglomerate moving along nicely.

Takeaway

Based on the data provided, it appears to me that General Electric, while not in such a poor state as to warrant continued pessimism from the market, is going to have a tough year in 2019. 2020 will likely also result in some pain for shareholders, but if management's own guidance is correct and this year can truly be the trough for the firm, then investors can and should take confidence that the future will be better. As I have said before, General Electric is a long-term prospect, and under no circumstance should investors see it as anything short of that.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.