GE: A Cash Flow Recovery Is Coming

Summary

• General Electric's free cash flow declined significantly in 2019, but still beat the company's initial full-year guidance by a wide margin.
• GE expects further cash flow improvement in 2020, despite headwinds from its asset sales.
• Free cash flow is poised to rocket higher over the next two years as the power and renewables segments start generating cash again.
• Annual free cash flow could reach $10 billion by the mid-2020s, making GE stock a great buy based on its current market cap of about $75 billion.

During 2019, General Electric (NYSE:GE) finally returned to relative stability after two awful years during which GE shares lost more than three quarters of their value. It was hardly a spectacular year, to be sure. Free cash flow fell nearly 50% year over year to $2.3 billion, and while adjusted EPS rose 14% (from $0.57 to $0.65), that was still less than half of the $1.49 GE reported for adjusted EPS in 2016.

Still, it was impressive that GE started to consistently beat and raise its guidance in 2019, after dramatically missing its forecasts in 2017 and 2018. Most notably, GE's full-year free cash flow of $2.3 billion was far better than the company's initial projection that it would burn $0-$2 billion of cash in 2019.

Last week, General Electric held its much-anticipated 2020 investor outlook call. During the call, GE described a multiyear plan to drive significant free cash flow growth over the next few years. Here's why investors should be optimistic about the prospect of significant improvement in the conglomerate's cash flow.

The 2020 outlook in brief

In late January, GE projected that it would generate $2 billion-$4 billion of industrial free cash flow in 2020. Last week, the company reaffirmed that projection, despite now expecting that the COVID-19 outbreak will reduce free cash flow by $300 million-$500 million in Q1, causing the company to burn approximately $2 billion this quarter.

Notably, GE's 2020 guidance doesn't incorporate any estimate of the potential impact of COVID-19 beyond the first quarter. The outbreak could significantly reduce free cash flow in a worst-case scenario. However, as CEO Larry Culp explained on the guidance call (see p. 16), "I think we decidedly did not take a view and would not necessarily encourage any extrapolations from what we've said here in the first quarter simply because what we don't know outweighs what we do know at this point in time."

Leaving this risk aside, GE's outlook calls for substantial cash flow improvement on a like-for-like basis. After all, GE still expects to complete the sale of its biopharma unit to Danaher (DHR) this quarter. Adjusting for that deal and other portfolio changes, GE's baseline 2019 free cash flow would have been just shy of $1 billion.

(Source: GE 2020 Investor Outlook Presentation, slide 41)

The biggest source of year-over-year cash flow improvement will be lower "inheritance items", such as cash used for legal settlements, restructuring, and unfavorable contracts. Working capital changes, which represented a $2.8 billion drag (see slide 5) on free cash flow last year, will be a much smaller headwind in 2020. Higher cash taxes and timing issues will partially offset these tailwinds.

Room for improvement in power and renewables

The most interesting part of GE's presentation was its multiyear forecast for continued cash flow improvement. At a high level, Culp said to expect high-single-digit free cash flow margins over the long term, which would imply annual free cash flow of roughly $7-$8 billion. While Culp didn't put a firm date on hitting that milestone, it looks to be reachable within 2-3 years. That would put GE well on its way towards my expectation of $10 billion in annual free cash flow by the mid-2020s.

The biggest source of improvement over the next two years will come from completing the turnarounds of the power and renewables segments. Together, they burned $2.5 billion last year, and GE expects limited improvement in 2020, with better results at GE Power partially offset by even greater cash burn in the renewables segment.

In both power and renewables, underperforming deals signed in 2016 and earlier have hurt free cash flow in recent years. The natural runoff of those deals is contributing to long-term cash flow improvements for both segments. GE has also cut costs in both business units and shifted its emphasis to profitability over growth, mainly via more conservative underwriting of new deals. And in renewables, the offshore wind business will begin generating revenue in 2021, when its Haliade-X turbine will begin shipping.

As a result, the power and renewables segments are likely to return to positive free cash flow soon regardless of market conditions. Currently, management projects that GE Power will start generating free cash flow in 2021, with further improvement in 2022, while the renewables business will move closer to cash breakeven next year before producing positive free cash flow in 2022.

(Source: GE 2020 Investor Outlook Presentation, slide 42)

Growth will continue in aviation and healthcare

Meanwhile, GE expects continued strong performance from its secular growth businesses: aviation and healthcare. GE Aviation is the company's main cash cow, contributing $4.4 billion of free cash flow last year. Management is calling for free cash flow in line with or slightly better than that figure in 2020, despite the 737 MAX grounding and a sharp drop in air traffic in Q1 (particularly in Asia). This highlights the segment's resiliency in the face of short-term disruption.

Given the high likelihood that the 737 MAX will return to service sometime in 2020 and the current COVID-19 panic will recede later this year, GE Aviation is likely to return to strong growth in 2021 and beyond. The expansion of the middle class globally and the declining cost of air travel has driven strong growth in air traffic over the past decade, and that trend isn't going away. Furthermore, GE Aviation ended 2019 with a massive $273 billion backlog (equal to 8 years of revenue), mainly consisting of long-term services contracts.

Healthcare is a slower-growth business but also holds plenty of potential. Excluding $1.5 billion of income from the biopharma business that is being sold, GE Healthcare earned $2.4 billion last year. The segment has ample room for margin expansion and is capable of high free cash flow conversion. As a result, within 2-3 years, GE Healthcare could match or exceed the $2.5 billion of free cash flow it produced in 2019, despite having sold the high-margin biopharma business.

A great time to buy

GE stock has plummeted due to the COVID-19 panic. Just a month ago, it hit a 52-week high above $13. By contrast, the stock closed at $8.21 on Monday, despite the bullish outlook issued last week.

Data by YCharts

Over the past two years, GE has dramatically improved its balance sheet, and it is likely to complete that process soon by closing the biopharma sale. That will give it a massive cushion to withstand any short-term disruption to its business from COVID-19. Meanwhile, the services-heavy nature of GE's business would partially insulate it from the impact of a recession.

As a result, GE is well positioned to boost free cash flow to the $7-$8 billion level by 2022 or 2023. There's plenty of room for growth beyond that point, driven by the secular growth of the aviation and healthcare businesses, as well as continued margin improvements for power and renewables. This strong baseline level of cash production will give GE plenty of firepower to deal with whatever headwinds inevitably crop up in the future.

With GE's market cap having plunged from more than $110 billion just a month ago to around $75 billion today, GE stock is trading at a massive discount to fair value based on its future cash flow potential. For investors willing to ride out the current period of volatility, GE stock has room to double over the next few years, far outpacing the market.

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Analyst’s Disclosure: I am/we are long 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.

Comments

[GaneshTrades]

Folks -
Is there an estimate, on the impact on GE cash flow due to additional demand for medical products such as ventilators?

[Old Wizard]

I believe the chloroquine drug treatment should be released for treatment for anyone who tests positive. The drug is already being used by doctors in NYC and California, for those who are very sick. I listened to an interview with a doctor there who has administered it to 100 very sick with the virus and none died. This drug has been around since .1944 and its side effects well known. It apparently has been successfully used in France and China. If it successfully limits the disease, it is a game changer and it behooves the FDA to be less conservative and give the go ahead. Doctors throughout this region have already ordered substantial quantities of the drug.

[gutcheck]

corona v could have one big positive effect for ge

[AncientAstronaut]

How?

[arok79]

what's that? end its misery and enter chp 11?

[farwest]

This article has to go down as one of the most ill-fated in recent memory. Just about every GE business will be crushed. They lucked out of a disaster in 2018/2019 but it was the lull before the storm.

[Adam Levine-Weinberg CFA]

I guess we'll see. I don't see this event sparking a repeat of the Great Recession. I could be wrong.

[User 50735431]

@farwest

"They lucked out of a disaster in 2018/2019 but it was the lull before the storm."

If by luck you mean that the Federal Government refused to let GE go into bankruptcy, then I agree.

Lehman & Bear, not so lucky to have that advantage.

The whole thing is rigged, some people are not allowed to lose though they so richly deserve it.

[Investing In The Bubble]

@farwest

GE's biggest profit center is aviation services. That business should be suffering for a while.

If Larry doesn't "just pull it" and warn the next time he opens his mouth, we'll have a better idea of how deep the fraud at GE really goes.

[Used user]

@Adam Levine
"Disclosure: I am/we are long GE"

Hope you sold

[Adam Levine-Weinberg CFA]

I sold ~15% of my position around $12 earlier this year. But it's a long-term investment for me. Happy to hold the rest for 3-5 years or more if that's how long it takes to reach fair value.

[Used user]

You are entitled to do what you want with your own money. If you believe they still can meet the cash flow forecast in these market conditions fine

I don't

[User 48291705]

"Fair value"?? When GE is BK, curious what you will assume is fair value for reverse split shares?

[Old Wizard]

By the way I agree that the number with the most uncertainty is how many people are infected. That is why, comparison of death rate to infections like the flu are questionable. Extrapolating the numbers we have now to the future is leading to more panic. First the global number we have is heavily weighted by numbers provided by China on their number of infections, those are probably way understated. Secondly, the death number is heavily weighted by the Chinese, Italian and Iranian numbers where health systems were inadequate and containment actions late to react. Thirdly our numbers in this country are too small to reach a final conclusion and we are just now beginning to be able to test a bigger sample.

[Old Wizard]

True, carnival has availed itself of a loophole in the tax code. It is a US company but it’s ships are registered in other countries. Their paying only1.1% of their profit Federal taxes is a fact. Might you feel the same about the Hedge fund managers who pay the low tax rate because of the carry loophole in the tax code. Are they profiting from the absolute panic selling of stock the last week and a half? Again, probably the cruising public share in the the benefit of the low tax rate by paying less to go on a cruise vacation. What benefit does the public get from the hedge fund managers loophole? The virus is to be taken seriously, but the reporting has unnecessarily hyped the problem to create the kind of panic that causes runs on toilet paper, bottled water and canned goods in Costco, and actions by politicians like calling out the national guard. Protecting 79000 people in New Rochelle , NY when many more thousands ride public transportation in NYC every day, often jammed in subways and buses hardly seems balanced.

[Keith Williams]

Hi Old Wizard,

Here is a very solid treatment of the coronavirus issue. It is a very serious problem. medium.com/...

[mk1992]

If one does a calcu on effect of this virus on GE's LTC liabilities, one would find it is measurable and positive: death rate for GE's LTC age group of 78 yrs old is 15%, infection rate is 1/3 to 2/3 depending who's doing the talking (US, merkel, canada), total LTC liabilities. And it will happen fast, within few months while all other liabilities are dragged out in multi years. No emotions, just basic math of Darwinism at work.

[mk1992]

I notice nobody dares to get near this post - no acknowledgement by author, no likes, no arguments for or against...... don't have to say it out loud you came near this post. Do the math and you'll be totally amazed the very fast large positive $ effect this virus will have on GE's pensions and LTC liabilities.

[Adam Levine-Weinberg CFA]

It's pure speculation at this point.

[User 50735431]

Speculating on the net positive effect to your financial position due to the effect of a viral pandemic from a possible bio-weapon release, it seems you presuppose that this virus will not mutate, and that you are likely to survive.

There's Darwinism, and then there's Dumbass.

You may be both, and I suspect Karma now has penciled you into her schedule.

[The Dark Knight]

Tusa was right! GE to $5 a share

[User 48291705]

Actually charles my call was 5 bucks in July 2018, wat before Tusa.

Don't believe me, then email Mike Slattery and he'll give you a pile on my predictions.

Tusa was oh so late to the GE party here.

[pkorn]

@Adam Levine-Weinberg CFA

"...$1.5 billion of income from the biopharma business...."

Selling it will prove to be a big blunder by Larry Culp.

Thanks for all the useful information you provide.

Regards

[Investing In The Bubble]

@Adam Levine-Weinberg CFA

Hi Adam, quick question for you. In the 2019 10K, GE shows the Industrials segment finished 2018 with $16.6B in cash & equivalents (page 65, 2019 10k).

In the 2018 10K, GE shows Industrials finishing the 2018 year with $20.5B (page 99, 2018 10k).

Pretty much all of the amounts for Industrials on these comparisons are different for the statement of financial position.

Is this due to the selling of assets during the year? What is the explanation on this?

-----Thanks

[Adam Levine-Weinberg CFA]

Without double-checking, I think it's almost certainly because of the deconsolidation of Baker Hughes during 2019. For the 2018 10-K, Baker Hughes was reported as part of GE, so its cash (and liabilities) were all on GE's balance sheet. Now that GE is no longer the majority owner, Baker Hughes' cash, other assets, liabilities, etc. aren't reported on GE's balance sheet (including for past periods).

[Investing In The Bubble]

@Adam Levine-Weinberg CFA

That's what I was thinking at first, but it doesn't add up. It does come close. Take a look at Accounts Payable, as an example.

The GE 2019 10K shows AP at $21.851B for year end 2018. The GE 2018 10K shows AP at $17.579B. The Baker 2019 10K shows AP at $4.025B.

$17.579B + $4.025B = $21.604B. The current 10K shows $21.851B.

The difference is $247 million.

Everything on the Capital side of the balance sheet appears to be the same.

On the statement of earnings, it's the same weird thing. The EPS loss of $2.62 is consistent with both consolidated statements.

But the GE 2019 10K shows Industrial sales of goods at $60.147B. The GE 2018 10K shows $74.854B. Baker shows $13.113B for this in their 2019 10K.

The difference here is $1.594B.

Any explanation? (You already know what I'm thinking.)

[Adam Levine-Weinberg CFA]

Probably other smaller asset sales. I'd have to dig into it to be sure.

[Old Wizard]

My prediction is that the hysteria and hype will be gone by the end of May. Several potential treatments are being developed by I believe up to 8 different companies. Hopefully at least one will be reasonably successful in mitigating effects of the virus. New infections in China and South Korea have apparently passed the inflection point where they are in significant decline. We clearly are not there domestically, but should that happen in the next two months, the collective actions of our people will revert quickly to normality.

[misultin70]

Italy waited for 18 hours the prime minister could close all production activities of the 8 industrial lift in the world GE has industries in the north and will be closed for 15 days, we await a press conference ...

[ArbLover]

"Last week, the company reaffirmed that projection, despite now expecting that the COVID-19 outbreak will reduce free cash flow by $300 million-$500 million in Q1, causing the company to burn approximately $2 billion this quarter."

I think people (many analysts included) are reading between the lines. Culp just said FCF would be impacted by 300-500mm this quarter. Earlier he had said the grounding of the MAX would reduce cash flow by ~1.5b. Then GE entered into an agreement where BA is going to pay them as engines are delivered, so they don't have to wait until they are sold. Naturally nobody asked him to clarify. To me this seems like he's setting up for an easy beat (again).

So, the question is has GE stopped delivery of engines and will they commence any delivery by 3/31? I believe they had halted or at least reduced capacity (temporarily laid off some temps), but have they picked up again given that the return to service seems like it's actualizing?

[James Coleman]

@ArbLover

You've stated the situation correctly re Q1. And perhaps Culp did (sneakily in my view) leave himself some wiggle room WHEN he made that statement.

The big BUTS to me are re Q2, and beyond and their reliance on BA, who as serndipity (sp?) pointed out in a post here today has drawn down their total credit lines. To me that is a BIG tell as it signals that the credit market is disappearing.

Thoughts?

TIA

\.

[ArbLover]

@James Coleman I was speculating on the credit line in a BA thread the other day. I think they are a little tighter on cash because they had to negotiate with some suppliers recently, and with some buyers to keep them interested. My thought is that this was GE in a good position saying we need money; if you cant keep paying we are going to deliver more to Airbus as we have the capacity. I believe BA is going to be fine given their cash flow provided they resolve this before Q3. I think they are trying to fight two other companies on the satellite race so maybe that's what it's for.

I added a small BA position yesterday with a June 21 exit timeframe. Only a small position because I could be wrong, but a good reason to draw down the line would be for business use, and I bet they got a very attractive rate.

[misultin70]

The covid19 will be devastating in the United States, non-state by taking no precautions and the focus on the economy will be devastating

[ArbLover]

Yes there have been 29 deaths, mostly because the virus infected a nursing home. Let's cause hype and hysteria because healthy people cannot go about their normal lives anymore, says the news.

Compare those 29 elderly deaths to the 12,000 US dead due to H1N1 by this time in March 10 years ago.

I'll add that both SARS and H1N1 peetered out in early April just as the seasonal flu.

You'd have more credibility if you said the seasonal flu was going to devastate the U.S. as it's already killed 20k people this year.

[ncvor]

The seasonal flu has a .1 death rate. The C19 has a 3.4 death rate and we know nothing about it, but I do hope you are correct that C19 is gone or limited by april - which is entirely an assumption regarding a virus we know very little about.

www.sciencealert.com/...

www.cdc.gov/...

Also, it is not just the news, but the CDC, WHO and many other health organizations discussing the unknown and serious nature of the virus. It shouldn't be hyped but also must be taken seriously.

[Adam Levine-Weinberg CFA]

I don't think COVID-19 will be gone by April. The vast majority of public health officials seem to think that maybe by May or June disease transmission will slow, but even then it won't come to a complete halt.

We really don't know the death rate for COVID-19 yet, because many people seem to be asymptomatic or have very mild symptoms and probably haven't been counted in the infected population. It seems clear that the fatality rate is higher than seasonal flu, but that's about all we know for sure.

[pkorn]

"...GE projected that it would generate $2 billion-$4 billion of industrial free cash flow in 2020."

Hi adam, Does that include a proportionate share of corporate overhead?

Thanks. Regards

[Adam Levine-Weinberg CFA]

Yes, that includes corporate overhead.

[Mike Slattery]

For reference, GE Corporate had negative "Free Cash Flow" (FCF) at -($2.1 Billion) in 2019.

For 2020, Culp in his presentation on March 4th (page 38) shows this Corporate FCF as being improved and estimated at about negative -($1.5 Billion)

[holding the bag]

3-6 month COVID panic, LOL. We are at the beginning of a massive GLOBAL downturn and the virus is not the cause, but simply the proverbial straw. Germany was in recession and Japan tanked 6.3% in Q4 before any virus. Now add in China idling (or at least half-idling) for almost the full quarter and consider any knock ons from there. Season with the oil plunge and resulting shale devastation (bankruptcies and loss of highly paid job and thus demand). GE Capital's insurance exposure is the icing on the cake.

Thinking things go back to business as usual within 6 months or even in 2021 is simply delusional.
I am initiating a short today (among multiple other stocks) and hoping for a substantial bull trap (into March OpEx perhaps?) to open a full position

[User 48291705]

Bingo holding.

This market has been way overpriced, and only a 12% loss thus far is just the beginning.

Let all these GE thumpers take the ride South.

Far better industrial stocks coming back down to earth, that will eventually be buys.

[James Coleman]

@hangloose Hawaii

Looks to me like the author's thesis re improved cash flow at GE will NOT a 2020 event.

[Adam Levine-Weinberg CFA]

I wouldn't dispute that there's a high likelihood of a global recession in 2020. But I don't think it will be "massive" or long-lasting. A sharp dip followed by a quick recovery is more likely, aided by rock-bottom interest rates and (most likely) fiscal stimulus.

[LifeLongMetsFan]

I would love to buy GE but the pension obligation prevents my investment. I just don’t understand how GE gets ahead of their obligation without vastly “restructuring” the pension program. It’s very sad.

[Adam Levine-Weinberg CFA]

In theory, if GE contributed the entire proceeds of the biopharma sale to the pension plan, the pension deficit would decline by 80%-90%. That's not how it will allocate the cash (some will go to pension but some will go towards repaying intercompany loans to provide cash that GE Capital can use to pay upcoming debt maturities). But the underlying point is that the pension deficit just isn't that big a number relative to the size of GE, the value of its assets, and the amount of cash it is likely to be throwing off a few years from now.

[User 48291705]

So Adam, you have a plan B when DHR bails on the deal?

You are way over the top on GE, but it's your money.

c ya @$5

[jshia888]

corona virus throw you a bone, huh?

[Tech Junkie]

Good article, and agree on the FCF recovery. While aviation demand will definitely drop, the fact that they have worked out payment terms with Boeing for the 737Max is good news.

I am long GE, have sold my position in Mid 2016 at 32.xx levels before but have since averaged down to low teens average price. I was in the green before the recent market correction, while I'm long GE but I wouldn't be entering new positions at GE anytime soon due to the market sentiments and that I believe other investments may be a better capital allocation for me.

Curious to hear your thoughts on their debt reductions for 2020. Obviously, the low-interest rates make the pension liabilities higher, but more importantly, Baker Huges share prices have sank and they still hold a rather significant stake that they have communicated they wanted to sell off on.

[Adam Levine-Weinberg CFA]

Thanks. The vast majority of the debt reduction would come from completing the biopharma sale (~$20 billion). By contrast, the YTD drop in the value of the Baker Hughes stake is maybe $4-$5 billion. (I haven't run the numbers today.) It's unfortunate but not a big deal in the grand scheme of things.

The pension could potentially complicate GE's attempt to get to the 2.5x debt/EBITDA target by year-end, but it's still really early in the year. I think there was something like a $6 billion move in the pension deficit between September 2019 and the end of last year, so there's no sense in getting too worked up about where the pension deficit sits on any given day.

[Tech Junkie]

Thanks for the quick reply.

Yes, I was thinking the 2.5x/EBITDA target could be missed because of Baker Huges and that this might put pressure on GE's stock price for the near future given how much emphasis has been placed on debt reduction and how this has been publicly communicated.

You're right on the pension, but again I have concerns on interest rates being higher for the foreseeable future.

Anyhow, I don't intend to sell my GE position and expect to be in the green in 1-3 years time but I could certainly see how one could be concerned if they were gonna put fresh money in.

Cheers!

[pkorn]

"...the price action across capital markets suggests the collectively intelligent market is genuinely concerned that the coronavirus is something different.

We would submit that is the case."

www.briefing.com/...