COVID-19 Sinks General Electric's Moat
Summary
- GE's Q1 revenue and segment profits fell by double digits Y/Y. Aviation's segment profits fell 39%.
- COVID-19 has caused air travel to free fall. Aviation orders are falling, and margins are shrinking. Aviation was expected to be a moat.
- Cost cuts at Aviation imply the unit is battening the hatches amid an uncertain outlook for air travel.
- FCF was -$2.2 billion. If FCF continues to fall, it could hamper GE's ability to service its $85 billion debt load.
- COVID-19 appears to have sank GE's moat. Sell the stock.
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Source: Barron's
General Electric (NYSE:GE) reported Q1 revenue of $20.52 billion, Non-GAAP EPS of $0.05, and GAAP EPS of $0.72. The stock is down in the low-single-digit percentage range post-earnings. I had the following takeaways on the quarter.
NewCo Loses Traction
GE's top line has included noise from the constant buying and divesting of companies. I have long-held the suspicion its industrial businesses have peaked. Aviation, Power Systems and Renewable Energy (NewCo) are considered core operations. In Q4, NewCo showed traction, growing revenue 3% Y/Y. In Q1 its revenue fell 7%. Revenue from Power and Aviation fell hard, while Renewable Energy bounced by double digits.
About 29% of total revenue was derived from Power, down from 31% in the year earlier period. Power has been a poor performer for a few years, but last quarter, the unit's revenue appeared to have stabilized. In Q1, Power's revenue fell 13% Y/Y. COVID-19 has had a negative impact on Power's supply chains and hampered its ability to close transactions. Lower oil prices and a dismal economy could negatively impact customers' budgets. This implies Q2 results could worsen.
Revenue from Renewable Energy bounced 26% as the onshore wind market benefited from the Production Tax Credit ("PTC") and a shift in customer preferences to larger, more efficient units to help lower costs. Onshore wind reported record deliveries in Q4, and management projects solid deliveries for much of 2020. The PTC has been a boon for the segment as previously predicted.
Aviation revenue fell 13% Y/Y, which followed a 6% rise last quarter. Aviation was expected to be NewCo's moat. The knock-on effects of COVID-19 may have changed the narrative. COVID-19 has led to social distancing and shelter-in-place orders. This has led to a free fall in air travel, demand for planes and aircraft engines. Airlines have grounded their fleets, while others have ceased passenger operations. According to Boeing (BA) CEO David Calhoun, passenger demand is down by 95% versus last year, and it could take a few years to return to normal. This implies Aviation could face headwinds for most of 2020. Orders fell by double digits during the quarter, yet Aviation's $273 billion backlog could serve as somewhat of a buffer. A decline in the backlog could be cause for concern.
Segment Profit Fell Hard
Q1 segment profits from NewCo were $574 million, down over 60% Y/Y. Segment profit for Power was -$129 million, down from $110 million in the year earlier period. Management continues to rightsize the business to align its objectives with market demand. The company is attempting to offset volume declines; in Q1, Power had about 700 headcount reductions and has executed a hiring freeze. Whether more cost containment efforts can stem operating losses remains to be seen.
Segment profit at Renewable Energy was -$302 million, down from -$187 million in the year earlier period. Segment profit fell on higher project execution losses and costs associated with product introductions. Such costs offset higher onshore wind sales. Meanwhile, segment profit at Aviation declined by 39% Y/Y due to a decrease in after-market volume for services, and lower volume of commercial spare engines. Given the grounding of several planes, Aviation's segment profit could fall hard in Q2 and slowly rebound after the economy reopens.
GE is reportedly slashing more jobs from its jet-engine unit, which implies the unit is retrenching. Aviation represented all of NewCo's segment profits. I felt the economy had peaked prior to the COVID-19; the pandemic may have exposed a weakness in the economy that already existed. That likely portends less opportunity for Aviation to grow profits towards the end of 2020 and beyond.
Cash Flow Fell
A key metric for GE is its industrial free cash flow ("FCF"). Asset divestitures have created so much noise that it is difficult to discern whether the company is making progress. However, if GE can throw off consistent cash flow, then that could be considered a win. In Q1, the company reported an FCF of -$2.2 billion, down $1.0 billion versus the year earlier period. Inventory was a challenge during the quarter:
Yeah, with respect to working capital, I think our primary challenge is really inventory at Aviation, right. We came into this year knowing we were going to have to adjust to a different schedule with the MAX chasing the step up at Airbus with the 320 Neo, while dealing with a good bit of past due on the commercial side both OE and aftermarket while having pretty good military demand to contend with that all gets reset here. And one of the real pressure that we saw from a cash flow perspective was in inventory at Aviation in the quarter.
Inventories rose from $14.1 billion in at Q4 to $15.5 billion. Usually, when a business retrenches, inventory also falls, creating a cash inflow. That was not the case this quarter. Slow-moving inventory could become a point of contention if Aviation clients pull orders or continue to retrench. GE needs consistent FCF to help pare its $85 billion debt load. Proceeds from its $20 billion sale of Biopharma will help, yet I estimate GE will remain highly-indebted even after the sale. Debt, FCF, and the diminution of its industrial businesses remain in focus.
Conclusion
COVID-19 appears to have sunk GE's moat. The stock remains a sell.
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