General Electric: This Is What Matters, For Now

Summary

• General Electric is scheduled to release Q2 2019 results on July 31, 2019.
• I cover the two things that investors should closely monitor this week (and for the rest of the year).
• 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) has been a battleground stock that has actually performed extremely well so far in 2019 (up over 38%). However, GE shares are still down almost 20% over the last year and have significantly underperformed the broader market.

Data by YCharts

2019 has been a good year for GE shareholders, but the company's management team still has a lot more to prove before the stock will be able to tick higher from here. To do this, management will need to continue to tell a good story, and the company's operating results for the next few quarters will need to impress. To this point, I believe that there are 2 things that investors should pay close attention to when GE reports on July 31, 2019.

The Two Things That Matter, For Now

There are too many moving pieces to get good read-throughs when it comes to GE's top- and bottom-line results. So, while these are important metrics, I believe that there are 2 things that should be front of mind - i.e., debt levels and margins.

Debt

GE having a subpar balance sheet wrecked major havoc as the company simply could not weather the storms that were caused by the downturn in the Power industry. Actually, the last 3 plus years have turned out to be a perfect storm (Oil and Gas downturn, SEC/DOJ investigations, the Alstom "disaster", pension charges, and the insurance reserve issues), so it was not only the struggling Power unit that negatively impacted GE's business. However, it should also be noted that some (if not most) of these factors were self-inflicted wounds.

As a direct result of these factors, in addition to the already deteriorating balance sheet, management had to make some extremely difficult decisions which consisted of spinning off/selling assets, restructuring, and basically eliminating the dividend.

More recently, however, management has done a great job reducing the outstanding debt and rightsizing the balance sheet.

$- in mill	Q1 2019	Q1 2018	% Chg
Cash, cash equivalents, & restricted cash	$34,905	$32,129	9%
S/T borrowings	15,953	19,371	-18%
Non-recourse borrowings	1,350	1,335	1%
L/T borrowings	90,223	105,134	-14%
Total debt (Note 1)	$107,526	$125,840	-15%
Net debt	$72,621	$93,711	-23%

Click to enlarge

Source: 10-K for Q1 2019 and Q1 2018; table created by author

Note 1: there are other liability accounts not included in the analysis above. See the linked 10-Ks for GE's total liability balances as of the period-ends.

As shown, GE's net debt balance was down by over 20% YoY. And looking back, GE has been able to significantly reduced its debt balance over the last 3 years.

Data by YCharts

I am expecting more of the same for Q2 2019. Investors should not only pay attention to the debt balance but, in my opinion, management's commentary will be just as important. I say all of this to say, GE's financial leverage and debt levels are critical to the overall story for this industrial conglomerate, so further progress will be well-received by the market.

Margins

Let me start by saying that GE’s earnings growth prospects will come, eventually. This company has been plagued by many one-time charges (try not to laugh) related to the insurance reserves, pension deficit, and failed acquisitions that have almost completely wiped out earnings for the last 3 years. Having said this, investors should expect earnings to remain under pressure for the foreseeable future as the company continues its restructuring efforts.

Therefore, investors should be interested in hearing more about industrial operating margins when the company reports next week. Looking back, margins for most of GE’s operating units have been negatively impacted by several factors with the most notable example being the downturn in the Power industry.

$ - in mill	2018	2017	2016	% Chg '16-'18
REVENUE
Power	$27,300	$34,878	$35,835	-24%
Renewable	9,533	9,205	9,752	-2%
Aviation	30,566	27,013	26,240	16%
Oil & Gas	22,859	17,180	12,938	77%
Healthcare	19,784	19,017	18,212	9%
Transportation	3,898	3,935	4,585	-15%
Lighting	1,723	1,941	4,762	-64%
TOTAL	115,663	113,169	112,324	3%
SEGMENT PROFIT
Power	(808)	1,947	4,187	-119%
Renewable	287	583	631	-55%
Aviation	6,466	5,370	5,324	21%
Oil & Gas	429	158	1,302	-67%
Healthcare	3,698	3,488	3,210	15%
Transportation	633	641	966	-34%
Lighting	70	27	165	-58%
TOTAL	10,775	12,214	15,785	-32%
MARGINS
Power	-3%	6%	12%	-125%
Renewable	3%	6%	6%	-53%
Aviation	21%	20%	20%	4%
Oil & Gas	2%	1%	10%	-81%
Healthcare	19%	18%	18%	6%
Transportation	16%	16%	21%	-23%
Lighting	4%	1%	3%	17%
TOTAL	9%	11%	14%	-34%

Click to enlarge

Source: Data from 2018 10-K; table created by author

The consolidated industrial margin is down 34% over the last 3 fiscal years and is now in single-digit territory. And more recently, GE’s operating margins for Q1 2019 left some investors wanting more.

Source: Q1 2019 Supplemental Earnings Report

There have been some positive developments related to the company being able to improve the cost structure for its industrial operating units, mostly with Aviation and Healthcare, but overall, margins have been a major component of most bear cases. In order for Mr. Larry Culp, CEO, to truly change the narrative, I believe that he will need to greatly improve GE’s margin profile.

Let’s consider the most extreme case for a moment. Honeywell (HON), which is best of breed in the industrial space, has margins that will make you laugh (or cry) when comparing them to GE.

Source: Honeywell's Q2 2019 Earnings Press Release

I do not expect for GE to be anywhere close Honeywell in the near term when it comes to margins, but, in my opinion, Mr. Culp has what it takes to at least start GE down the path of playing catch up. This alone will have a material impact on investor sentiment.

Risks

Upside Risk Factors - (1) Additional asset sales, (2) expanding margins, (3) improving cash flow metrics, and (4) better-than-expected Power results.

Downside Risk Factors - (1) Concerns related to BioPharma deal, (2) margin pressure outside of the Power unit, (3) deteriorating cash flow metrics, and (4) additional restructuring needs for the Power unit.

Bottom Line

Make no mistake about it, there are plenty of metrics/ratios that investors should be interested in hearing more about when GE reports Q2 2019 results, but I believe that the company’s progress made toward improving its financial leverage and operating margins should be on the top of the list. Plus, let’s also remember that management already called for GE’s cash flow metrics to remain under-pressure through 2019, so this should already be baked into expectations.

Any way you slice it, GE is a 3 to 5-year story that will take time to play out, which means that any 1 quarter will likely not make or break the investment case for this once great company’s turnaround. However, promising Q2 2019 results will go a long way toward improving investor sentiment, which has the potential to be a significant near-term catalyst for the stock.

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