General Electric: Assessing If Power's Negative Cash Flow May Prompt A Ratings Action

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About: General Electric Company (GE), Includes: ALSMY, AOMFF, SIEGY, SMAWF
by: Shock Exchange
Summary

GE CFO Jamie Miller suggested Power would experience "significantly negative cash flow."

SIEGY is spinning off its Power and Gas segment.

Miller may have confirmed the rating agencies' worst fears.

Will Power's demise prompt a ratings action?

GE employee works on a gas turbine in France. Source: Barron A GE employee working on a gas turbine in France. Source: Barron's

Major asset sales have made it difficult to project future earnings of General Electric's (GE) core businesses - Aviation, Power Systems and Renewable Energy - or ("NewCo"). GE CFO Jamie Miller recently divulged the company expects Power to have very significant negative cash flow this year:

General Electric (GE -0.5%) expects "very significant negative cash flow" from its core power plant business this year and does not anticipate large improvement in the unit's cash flow margins for at least three years, CFO Jamie Miller said today at a Goldman Sachs investor conference.

GE expects some power plant orders it booked in Q1 to be spread more throughout the year, Miller said, suggesting the relatively strong quarter did not signal a turnaround in the unit.

Some investors see signs of improvement in GE's ailing power business but others see problems; J.P. Morgan's Stephen Tusa says a tally of orders by GWs shows erosion in GE's market share.

Despite asset sales and constant media appearances from CEO Larry Culp, Power's demise has been consistent. I had the following takeaways on the announcement.

Power's Demise Continues Unabated

Power has been a concern for GE since its revenue started to decline in the second half of 2017. The unit was expected to be a growth engine, particularly after the company acquired Alstom's (OTCPK:ALSMY) (OTCPK:AOMFF) Power division. Management vowed to turn Power around, yet the unit has been hard hit by falling orders, declining margins, and disruption by alternative energy sources.

NewCo got off to a rough start in Q2 2018, and management implied GE could miss its full-year free cash flow ("FCF") projections. Within months, Culp was named to replace former CEO John Flannery. The new CEO has brought plain talk and more asset divestitures, yet NewCo has continued to underwhelm. In Q1 2019, NewCo's revenue and segment profits fell 5% and 19%, respectively. Segment profits for Power were a paltry $80 million. Power's demise is likely causing a crimp in GE's FCF.

GE Q1 2019 cash flow FCF for full-year 2016 and 2017 was $7.1 billion and $5.6 billion, respectively. It fell to -$1.2 billion in Q1 2019. Asset sales have helped energize bulls and buoyed the share price. It may take a few quarters to determine if GE is better off after divesting stakes in Transportation, Healthcare and Baker Hughes (BHGE). The company has also been known for its opaqueness; FCF is the one thing that has not been opaque.

Deteriorating FCF suggests the business is not healthy. Management suggests this is fixable. If the economy has peaked, then shouldn't FCF fall? In my opinion, GE may have wasted good economic times to engage in share buybacks and acquire Alstom's Power business at market heights. I believe the economy has peaked. If that is the case, then revenue and earnings from GE's industrial businesses should be stagnant to declining.

In its most recent quarter Siemens (OTCPK:SIEGY) reported a 4% decline in revenue at its Power and Gas segment. The segment has performed so poorly that Siemens decided to spin off the operation. Siemens is effectively throwing in the towel. This implies GE's Power business could get worse before it gets better.

Will The Rating Agencies Move On GE?

In Q4 2018, Moody's downgraded the company's senior unsecured debt two notches from A2 to Baa1; the downgrade was due to Power's deteriorating operating performance and its negative impact on cash flows. In Q1 2019, Fitch revised GE's credit from Stable to Negative over risks to Power, FCF and support for GE Capital. GE's CFO appears to have confirmed the fears of Moody's and Fitch pursuant to Power and the company's deteriorating cash flows. Will it be enough for the rating agencies to downgrade GE's debt again?

I am on record that simply based on GE's credit metrics, its debt appears to be at junk status. Management has been given ample time to (1) rightsize Power, (2) raise equity to pare debt or (3) sell assets to pare debt. Nonetheless, GE's credit metrics likely imply a downgrade could be warranted.

Conclusion

A ratings downgrade could amplify GE's interest costs, hurt cash flow and/or hurt sentiment for the stock. Jamie Miller may have confirmed the worst fears of the rating agencies. Sell GE.

Disclosure: I am/we are short 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.