General Electric's Pain: What To Watch For

Apr. 13, 2020 2:17 PM ETGeneral Electric Company (GE)11 Comments

Summary

  • The management team at General Electric recently announced that the near-term financial results for the conglomerate will be impacted by the COVID-19 pandemic.
  • The degree of pain caused by this is significant, but the firm can weather it for now.
  • Investors should watch backlog and pay attention when earnings are next reported to see how long this might affect the enterprise.
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General Electric (NYSE:GE) and its shareholders just never can seem to catch a break. For a couple of years, the industrial conglomerate struggled with a weakening Power segment and bloated Corporate and Capital segment structures. After that, it was hit by other issues like the fallout associated with problems with the 737 Max aircraft built by Boeing (BA). Just as things were starting to look up for the firm, a global crisis, COVID-19, hit. This will have a material impact on the firm short-term, and investors in the business should keep an eye out on certain items when the firm reports first-quarter results later this month. However, just like past crises, this too should pass.

Management's own thoughts

Just like many companies dealing with the COVID-19 crisis, General Electric has been fairly transparent when detailing what the fallout of recent events will look like. No firm can provide absolute certainty. After all, the depth of the crisis is currently not fully known and the duration of it is unknowable at this time. What guidance management has provided is, in a sense, encouraging. But at the same time, it paints a rather ugly picture for the business near-term.

Back on March 4th, before the company knew how bad things might get, management stated that this year should be pretty good. General Electric was expecting to see adjusted earnings per share for 2020 of between $0.50 and $0.60. This included earnings of $0.10 per share in the first quarter this year. Its Industrial level free cash flow, meanwhile, was on track to range between $2 billion and $4 billion.

To further bolster its business, management announced on March 23rd that it was taking drastic actions at its flagship Aviation segment. This included a 10% reduction of its US workforce, the lack of work affecting 50% of its US maintenance, repair, and overhaul employees for 90 days, a hiring freeze, and more. The full impact of these changes is unknown. However, management does believe that these actions will help to reduce cash costs by between $500 million and $1 billion for the year.

Another thing that should help the company is the closing of its BioPharma sale. Last year, management struck a deal whereby Danaher (DHR) would acquire General Electric's BioPharma unit of its larger Healthcare segment. On March 31st, management announced that the deal had been completed. In exchange for this sale, General Electric received gross proceeds of $21.4 billion. $0.4 billion of this was in the form of the assumption of certain pension liabilities. Deal taxes, fees, and more accounted for roughly $1 billion, leaving the company to collect net cash proceeds of around $20 billion. This does not have anything to do with the COVID-19 fallout itself, but the hefty cash proceeds, which management had planned to allocate toward debt reduction, will help to keep it running as well. Investors should not expect, then, for all of these proceeds to go toward debt now.

The final development, so far, came courtesy of management on April 9th. In a press release, management stated that investors should now expect a significant hit to the firm as a result of continued economic weakness driven by COVID-19. Management did not give too much detail, but it did state that first-quarter earnings should be substantially lower than the $0.10 per share profit the company anticipated when it last issued guidance. Total Industrial free cash flow should now be around -$2 billion. That's a huge hit to the firm. Though cost-cutting is helping to alleviate some of the firm's issues, significant uncertainty across the company's end markets, operations, and supply chains is more than offsetting that.

As management and shareholders gear up for the firm's first-quarter earnings release, which will be announced on April 29th, there's a lot that investors should watch out for. In particular, investors should pay special attention to the firm's Aviation segment. Even though the unit operates under contracts, some of which are arranged years in advance, the halt of the airline industry is sure to affect, at minimum, the timing of the company's activities. Previously, management expected the segment to generate free cash flow that was flat or up compared to last year's $4.4 billion. However, it's likely this segment will have been hit the hardest for the firm.

In 2019, General Electric's Aviation segment ended the year with $273 billion worth of backlog. This represented a 22% increase over what the firm generated in 2018. One thing investors may want to watch out for would be contract cancellations. Backlog may still grow, but if contracts are cancelled by customers, then this growth might be slow compared to prior years. This could be the most significant data in evaluating whether the COVID-19 crisis remains a short-term problem or if it will extend to become an intermediate-term one.

The other big area investors will want to keep an eye on is the firm's Power segment. For years, this segment, once General Electric's largest and most profitable, has been a drag on the business. Last year, it generated free cash flow of -$1.5 billion. In prior guidance, issued on March 4th, management said that this year the segment would see "better but negative" free cash flow of an unspecified sum. It would only be in 2021 that free cash flow would turn negative for it. This should now be seen as firmly in doubt, with demand for the units likely to decline during this time of weak economic performance. How negative, particularly this early on in the downturn caused by COVID-19, will be really insightful.

Takeaway

Right now, investors are right to be uncertain about the near-term and possibly even the intermediate-term future facing General Electric. The industrial conglomerate keeps getting hit down every time it stands back up. Fortunately, the completion of its recent BioPharma sale should help, when combined with other cost-cutting initiatives, to keep the entity afloat. Ultimately, I do believe the firm makes for an attractive long-term play, but for now the thing investors who like the business need to do is to wait.

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This article was written by

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Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and 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.

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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