General Electric: A Positive Outlook, After The 'Reset' Of Course

Summary

• General Electric released its 2019 outlook material, and management called 2019 the "reset" year.
• Management disclosed financial leverage targets for General Electric's industrial and financing businesses, and it expects the company's financial position to greatly improve by 2021.
• I am long General Electric, and I plan to stay long the stock.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

General Electric (NYSE:GE) recently released its 2019 outlook and, as you can expect, the next year is going to be a long and challenging journey for this industrial conglomerate. Management called 2019 a "reset" year. The stock was initially down big after the outlook call, but shares recovered and finished the trading week higher by around 4%.

Data by YCharts

While 2019 is projected to be a reset year, I believe that the bull case gets stronger the longer that you are able (and willing) to look out. Mr. Larry Culp, CEO, has communicated in great detail the challenges that his team will face in 2019 (with the Power struggles taking center stage), but I believe that nothing has stood out more than the focus that is being placed on GE's financial position, and rightfully so. In my mind, Mr. Culp's success will be largely tied to his ability to improve GE's leverage, and this is the reason why I have covered the topic several times in the recent past (see here for the latest example).

This article will include updated thoughts on GE's financial position based on the outlook material, and I will describe the plan that management laid out to put this company in a better financial position by 2021.

The Company Has Debt, On Debt, On Debt - But There Is A Plan

During the outlook call, Mr. Culp said that his number 1 priority was to run "the company with a higher cash balance and less reliance on short-term funding". GE's debt has been an issue for years now, so I am encouraged by the CEO's laser focus on reducing the company's financial leverage. To this point, management clearly identified financial targets for both GE Industrial (i.e., the industrial operating segments) and GE Capital.

Source: 2019 Outlook Presentation

This is the first time that I can recall that management disclosed financial targets for the two entities (yes, GE is only one company, but it is obvious that management now views/manages the industrial and financing units as two distinct businesses), which tells me that it is indeed serious about making changes.

For GE Industrial, management has plans to reduce the net debt-to-EBITDA ratio to less than 2.5x, which is a figure that it wants to stay under in the future.

Source: 2019 Outlook Presentation

As shown, it is important to note that management anticipates that the already announced asset sales will bring in almost $40B in capital over the next two years, so I do not believe that the industrial side of the business is in a dire situation, even after factoring in the $12B intercompany loan that will be paid down over this period of time (full disclosure: I am sure that management has some optionality when it comes to the intercompany debt, if need be).

Let's now dig a little deeper into the net debt balance for the industrial businesses:

Source: Supplemental Report from 2019 Outlook Presentation

Observations:

• GE owes a material amount in operating leases (a "debt" balance that I did not disclose in the past).
• A significant portion of the net debt balance is related to intercompany loans, which may provide some flexibility for Mr. Culp and team.
• GE Industrial has a net debt balance of $55B, but management expects to receive $38B in capital from the asset sales (an estimate that may turn out to be too conservative).

The story is a little better for GE Capital.

Source: 2019 Outlook Call

Notice the fact that GE Industrial and GE Capital have different financial targets (net debt/EBITDA vs. debt/equity). This shows how the financing business relies heavily on debt and, as you can expect, is the exact reason why pundits (including myself) have been calling for GE to return to its industrial roots. On a positive note, management finally appears to be serious about making GE Capital a thing of the past.

The shrinking of GE Capital has largely been lip service in the recent past (after "The Pivot", of course), as management was never able to provide a detailed path forward for how it was going to "de-emphasize" the financing business. It is a different story now under Mr. Culp, which should be viewed as positive news.

While the asset sales are key to GE improving its financial position, management also anticipates the company's cash prospects to significantly improve through 2021 due to cost savings from restructuring efforts and a positive change in industrial free cash flows.

Source: 2019 Outlook Presentation

Management is guiding for negative-to-flat industrial free cash flows, but the years ahead are projected to be big improvements - i.e., short-term pain for long-term gain, notice the "investments" being made (supply chain/restructuring/corporate/contingency). Every major restructure effort has to start with a plan and, if you ask me, Mr. Culp has done a great job laying out a detailed plan for righting the ship. Now the proof will be in the pudding.

Make No Mistake About It, GE Is An Expensive Stock Right Now

Based strictly on the numbers, GE shares are expensive when compared to its peer group. For example, management guided for adjusted 2019 EPS to be in the range of $0.50-0.60, which means that shares are trading at 20x estimated earnings (based on the low end of the range).

Source: 2019 Outlook Presentation

Data by YCharts

As shown, the company's competitors are trading below the 20x earnings mark. However, one quick point to make: An ~$0.40 headwind (~$0.20 in restructuring and another ~$0.21 in non-operating benefit costs) is factored into the 2019 estimated EPS, which has the potential to turn into a tailwind in 2020/2021. This is the reason why people, including myself, believe that GE is expensive based on current estimates, but the stock could turn out to be attractively valued if Mr. Culp gets the job done.

Risks

Downside risks: (1) The company has significant additional fines related to the DOJ/SEC investigations, (2) Power takes longer than 18-24 months to recover and burns through cash, (3) management has a fire sale and disposes of assets at rock-bottom prices, (4) the company's credit rating hits junk status, and (5) additional insurance reserve charges are booked.

Upside risks: (1) The spins [Transportation, Healthcare, and Baker Hughes] bring in more capital than anticipated, (2) the pension deficit shrinks as a result of the positive tailwinds, (3) well-known investors put money to work in GE which leads to a positive change in sentiment [e.g., Mr. Warren Buffett], and (4) Mr. Culp continues to win over the market.

Bottom Line

The main takeaway from the 2019 outlook material (the presentation slides and the conference call) is that Mr. Culp appears to be the right guy to turn around this large, complex conglomerate that lost its way many years ago. The presentation slides and call transcript (linked above) are must reads for anyone interested in GE as an investment.

As I have described in the past, GE's balance sheet is a significant risk factor, but I believe that the company has the levers to pull to change the narrative 2019 and beyond. GE is still a 3-to-5-year story, but I believe that the stock is a great, long-term investment, if it meets your risk/return profile.

Author's Note: I plan to dig deeper into the details and provide my thoughts on GE's individual operating segments so stay tuned. If you have any specific questions, please send me a message or leave a comment below.

Disclosure: I am/we are long GE, HON, UTX. 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.