General Electric: Steppin' In The Right Direction

Summary

• General Electric reported solid Q2 2019 results, but the stock finished the week lower by ~5%.
• The company beat bottom-line estimates and management raised their full-year 2019 guidance for EPS and cash flows.
• I plan to remain long General Electric.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

On July 31, 2019, General Electric (NYSE:GE) reported what I would call solid Q2 2019 operating results, but the stock remained under pressure due in large part to overall market concerns (i.e., the trade war shenanigans and the Federal Reserve's jumbled communication on future interest rate expectations). However, GE shares are still outperforming the broader market by a wide margin so far in 2019.

Data by YCharts

But, yes, GE shares are still down big over the last 1-, 3- and 5-year periods. While the company still has a long way to go, Mr. Larry Culp, CEO, already has General Electric heading in the right direction, and the Q2 2019 results were, in my opinion, another step forward for this industrial conglomerate.

The Results, Steppin' In The Right Direction

On July 31, 2019, General Electric reported adjusted Q2 2019 EPS of $0.17 (beat by $0.05) on revenue of $28.8B (in line with estimates).

Source: Q2 2019 Earnings Presentation

The highlights:

• Organic industrial revenue and orders were up 7% and 4%, respectively. Additionally, the Q2 2019 backlog came in at almost $400B (up 11%).
• Adjusted industrial cash flow was -$1B, but this number was at the high end of management's prior guidance.
• Management raised their full-year EPS and cash flow guidance (more on this below).

There was a lot to like about General Electric's Q2 2019 results (too much to cover in one article), even after factoring in the 737 Max concerns and the goodwill impairment for Grid Solutions. In this recent article, I explained to the Seeking Alpha community that there were 2 metrics (margins and financial leverage) that investors will need to pay close attention to throughout the current year.

For margins, the company's Q2 2019 operating results were less than impressive.

	Three months ended June 30			Six months ended June 30
$ - in million	2019	2018	% Chg	2019	2018	% Chg
REVENUE
Power	$4,681	$6,261	-25%	$9,298	$12,209	-24%
Renewable Energy	3,627	2,883	26%	6,165	5,722	8%
Aviation	7,877	7,519	5%	15,831	14,631	8%
Healthcare	4,934	4,978	-1%	9,616	9,680	-1%
Oil & Gas	5,953	5,554	7%	11,569	10,939	6%
TOTAL REVENUE	27,072	27,195	0%	52,479	53,181	-1%
PROFIT
Power	$117	$410	-71%	228	654	-65%
Renewable Energy	(184)	85	-316%	(371)	196	-289%
Aviation	1,385	1,475	-6%	3,046	3,078	-1%
Healthcare	958	926	3%	1,740	1,660	5%
Oil & Gas	82	73	12%	245	(70)	450%
TOTAL SEGMENT PROFIT	2,358	2,969	-21%	4,888	5,518	-11%
MARGINS
Power	2%	7%	-62%	2%	5%	-54%
Renewable Energy	-5%	3%	-272%	-6%	3%	-276%
Aviation	18%	20%	-10%	19%	21%	-9%
Healthcare	19%	19%	4%	18%	17%	6%
Oil & Gas	1%	1%	5%	2%	-1%	431%
TOTAL MARGINS	9%	11%	-20%	9%	10%	-10%

Click to enlarge

Source: Data from Q2 2019 10-Q; table created by author

Observations from the table:

• The Power struggles are obvious, right? But, it is important to note that the margins for Aviation were also down YoY. Management did, however, call for margins for this business unit to improve over the next two quarters.
• The margins for Healthcare and O&G improved materially over the first six months of 2019, which will likely continue to be the case through the remainder of the year.
• Renewable Energy's results were impacted by charges that were taken during the quarter. Additionally, this segment is not material enough to move the needle, yet.

There was not much to like about the margin results for Q2 2019, but, as described below, management still expects for margins to stay flat or slightly expand in the current year. That does not sound too encouraging, but let's remember that Power will be contending with stiff headwinds over the next six months and there are other factors that will likely also be coming into play (trade/tariffs, 737 Max, etc.). So, flat margins may not be as bad as you may think.

On the debt front, General Electric's financial position improved again during the latest quarter.

$ - in mill	Q2 2019	Q2 2018	% Chg
Cash, cash equivalents, & restricted cash	$31,968	$34,847	-8%
S/T borrowings	15,620	12,821	22%
Non-recourse borrowings	1,423	1,875	-24%
L/T borrowings	88,735	95,234	-7%
Total debt (Note 1)	$105,778	$109,930	-4%
Net debt	$73,810	$75,083	-2%

Click to enlarge

Source: Q2 2019 10-Q; table created by author

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

A 4% reduction in debt may not seem like much but, in my opinion, it is meaningful given all of the other issues that this management team is dealing with. Moreover, this company has several levers that it can pull to further improve its financial position in the quarters ahead.

Source: Q2 2019 Earnings Presentation

Noteworthy is the news that the BioPharma deal is still on track, which is a transaction that will bring in $20B+ in cash proceeds. Additionally, investors should expect for General Electric to also begin to monetize its Baker Hughes (BHGE) stake in the [nearish] future.

And looking ahead, management was confident enough to raise their full-year guidance after reporting what I would call solid Q2 2019 results.

Source: Q2 2019 Earnings Presentation

Yes, each year since 2017 has been a "reset" year. The BioPharma deal will do wonders for General Electric's balance sheet issues, so I believe that this transaction should be viewed as the number 1 short-term catalyst for 2019.

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) further margin pressure outside of the Power unit - i.e., Aviation, and (3) deteriorating cash flow metrics.

Bottom Line

Mr. Culp and team have General Electric steppin' in the right direction. Margins are still a problem, but, as management described during the conference call, this company is investing the necessary time and resources to change the results. General Electric appointed new leaders to focus on operational transformation and lean management, in addition to allowing Russell Stokes to focus his attention on the Power turnaround, so investors should expect to see improvements through 2020. Mr. Culp gave a few examples during the call of cost saving efforts that were already put into place, but the proof will be in the pudding.

From a financial position standpoint, Mr. Culp has already made significant progress toward rightsizing General Electric's balance sheet. And he has more levers to pull that have the potential to greatly improve this company's financial position. The BioPharma deal is the catalyst, but the Baker Hughes and Wabtec (WAB) stakes are other assets that will likely be monetized over the next 12-18 months.

Lastly, investors should not overlook the raised full-year guidance. What's not to like about stronger earnings potential and cash flow prospects, in addition to spending less on restructuring efforts? Moreover, Mr. Culp will now be able to bring in his CFO, which will be a big part of the turnaround story. GE is definitely a 3- to 5-year story that will take time to play out, but I believe that the Q2 2019 results were another step taken in the right direction. As such, long-term shareholders should seriously consider staying the course.

Disclosure: I am/we are long GE, WAB, BHGE. 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.