- The management team at General Electric decided to give shareholders a glimpse into the conglomerate's foreseeable future.
- The business does seem to have some issues still moving forward, but the fact of the matter is that the future is looking much better.
- Investors should be optimistic, especially if transitory issues resolve quickly this year.
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Every year, the management team at General Electric (NYSE:GE) gives an in-depth look into its own expectations for the industrial conglomerate's current fiscal year. With 2019 now out of the way, March 4th made sense for management to peer into the future and see the ups and downs of the 2020 fiscal year. Not surprisingly, there are a lot of bumps expected for the business and shareholders need to be prepared for them. But at the same time, there are also a lot of positive aspects that warrant consideration and appreciation. In all, the company is showing continued signs of recovery, and while I expect 2020 to result in some headaches for the firm, it should also be the definitive turning point for the business that leads it back to high-quality status from an investment perspective.
Some bumps along the way
Before we get to the good news, let's hop into the bad. The most interesting thing in management's guidance was the amount of detail associated with the coronavirus, COVID-19. According to management, this will have negative impacts across many of its business operations, but the largest impact will likely be related to the firm's Aviation business. After all, aircraft in General Electric's fleet have seen departures in China decline by 60% as a result of the outbreak. Service billings have dropped as a result of this as well.
On the whole, the Asia/Pacific region of the world accounts for 35% of all global air traffic. According to the IATA, it's estimated that RPK (revenue per kilometer) in the airline industry will drop 28% from December/January to January/February. It'll then go on to drop another 38% in February/March. Management has been wise not to make assumptions for anything beyond the first quarter, because there's no telling just how long or how bad the pandemic will last. Between all of the aforementioned factors, as well as reduced commercial demand for the firm's Healthcare, Power, and Renewable Energy operations, as well as associated supply chain difficulties, the company believes that COVID-19 will negatively affect free cash flow by between $0.3 billion and $0.5 billion during the first quarter this year. All guidance discussed later in this article assumes issues don't persist beyond the first quarter.
Two other issues for General Electric for the current fiscal year are the firm's continued pressure from the 737 Max and weakness associated with its Renewable Energy business. In the former, management did not actually provide any detailed guidance, but last year it said that an impact from the 737-Max of around $0.4 billion per quarter was realistic. If the aircraft does get the okay to fly again by mid-year, the impact on the business should end up being minimal, but any guess on this front is speculative in nature. On the Renewable Energy side, tailwinds caused by costly past projects have hurt the business. That looks set to continue this year. This will namely be in the form of reduced revenue associated with the company's grid and hydro operations. As a result, free cash flow for Renewable Energy will be worse than the -$1 billion seen last year. Only come 2021 will we see this improve some.
The good news is worth the pain
While investors need to be prepared for continued uncertainty, the good news is that there's plenty of good developments to offset this. The most obvious is free cash flow as projected by the firm. As of now, management is forecasting industrial free cash flow for the conglomerate to come in at between $2 billion and $4 billion. This will be driven by revenue growth in the low single digits and an improvement in the company's margins of 37.5 bps (basis points) at the midpoint and 75 bps at the high end. To put this in perspective, industrial free cash flow in 2019 was only $2.3 billion, so while 2020 could end up lower than 2019, that would be unlikely.
The real drivers of progress for the firm this year will be its Aviation segment and its Power segment. Aviation is forecasted to grow at the low-single-digit rate this year and next. Its margin this year should approximately match last year's figure, meaning that when combined with increased sales, its free cash flow should be either flat or above compared to the $4.4 billion seen in 2019. In 2021, this should continue to improve as margins expand further. Power, meanwhile, will see improvements in both sales and margin, but in 2019, the segment generated free cash flow of -$1.5 billion. This will leave it still in the red this year, though it is expected to turn positive come 2021.
Improvements are not just taking place at General Electric's largest segments. They are also taking place at the firm's corporate level. Back in 2019, the firm's corporate operating costs totaled $1.7 billion. Continued restructuring by the business will result in this figure dropping to between $1.4 billion and $1.5 billion this year. Though this is a material improvement, if achieved, the real improvement is expected to come in 2021 when corporate operating costs are forecasted to decline to only around $1 billion annually.
Another positive development for General Electric relates to the firm's deleveraging. Investors already knew that the company was well on its way to an industrial leverage ratio of 2.5 or lower, but management decided to reaffirm that now. This year, the company is looking at at least $23 billion in deleveraging activities. This should be easily funded though. After all, it still intends to close its BioPharma sale in the current quarter, with net proceeds from that coming in at around $20 billion. The company also plans to continue selling off its stock in Baker Hughes (BKR), though it did not disclose how much or what its expected proceeds are from it. While I believe divesting of an energy services firm is not the way to go, the reduced leverage and emphasis on core operations is a major positive.
Right now, I understand why some market participants are wary of General Electric. This is especially true with issues like the 737-Max and the new pandemic known as the coronavirus. Both of these could still throw a meaningful wrench into General Electric's plans, but anything like that should be viewed as one-off concerns that don't reflect the true value potential of the business. In all, General Electric is doing well for itself and its shareholders, and I believe that it's only a matter of time before this shines through in the form of improved financial standing.
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This article was written by
Daniel is an avid and active professional investor. He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.
Analyst’s 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.
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