General Electric: Q2 Cash Burn Could Trigger A Ratings Action

Summary

• CEO Larry Culp divulged GE could have a Q2 cash burn of $3.5 billion to $4.5 billion.
• GE could be hard-pressed to generate positive FCF for full-year 2020.
• The pandemic has hurt revenue and operating income for Aviation, the company's remaining moat.
• I estimate GE's proforma debt-to-EBITDA exceeds 6x. It could worsen amid cash burn.
• A ratings action could be warranted. Sell GE.
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General Electric CEO Larry Culp. Source: Barron's

The constant buying and selling of assets have made it difficult to forecast General Electric's (NYSE:GE) future earnings. Aviation, Power Systems, and Renewable Energy - or ("NewCo") - are considered core. The coronavirus has hurt commercial air travel and created headwinds for Aviation, the company's remaining moat. CEO Larry Culp recently divulged GE could have Q2 cash burn of $3.5 billion to $4.5 billion:

General Electric (GE.N) expects to burn more cash than expected in the second quarter, as the industrial conglomerate struggles with weakness in its aviation business due to the coronavirus crisis, Chief Executive Officer Larry Culp said on Thursday.

Shares of GE, which makes aircraft engines and power plants, fell as much as 3.6% to $7.03 after Culp also warned that the company's 2020 free cash flow will be negative.

GE's second-quarter free cash outflow is expected to be between $3.5 billion and $4.5 billion, he said at a conference. That was bigger than analysts' average estimate of an outflow of $2.5 billion, according to Refnitiv IBES data.

Over the past few years, investor sentiment has been highly-sensitive to cash flow. GE has constantly hived off assets, making its operating performance and valuation metrics rather opaque. On the other hand, cash flow and liquidity have been easier to track. This likely explains why they have received so much attention.

I have been a GE bear for quite some time. However, the company's historical free cash flow ("FCF") has not been as bad as I had expected.

For full-year 2017, 2018, and 2019, the company generated FCF of $5.0 billion, $2.1 billion, and $6.4 billion, respectively. During that time frame, GE Aviation has been a moat for the company. Military spending on aircraft has been robust, given President Trump's focus on maintaining a powerful military. Commercial air travel has also been robust, creating even more demand for aircraft engines.

I have long held the suspicion that the economy has peaked and commercial air travel would not hold up. Up until Q1 2020, I had been proven wrong. The coronavirus took hold in February, which caused people to stay home, hurting air travel. Boeing (BA) CEO David Calhoun previously suggested passenger demand was down 95% versus last year, and it could take years to recover.

Q1 revenue for Aviation fell by double-digits and its segment profits fell over 35% Y/Y. Aviation's performance hurt cash flow; GE's Q1 FCF was -$88 million, which was disappointing. If Q2 FCF represents an outflow of $3.5 billion to $4.5 billion, then FCF for total 2020 could be negative. The economy will eventually reopen, yet the consumer could be weak. The April unemployment rate was 14.7% - a postwar high. Going forward, consumers could focus their spending on essential items; headwinds for commercial air travel and GE Aviation could persist.

Will The Rating Agencies Move On GE?

GE's deteriorating FCF suggests its remaining operations are unhealthy. GE bulls can blame the pandemic. However, GE's industrial operations were likely vulnerable prior to the pandemic. The coronavirus likely exposed a weak global economy. In better times, GE used its cash flow for share repurchases, a foray into oil and gas, and ill-timed acquisition of Alstom's Power business. Management has since hived off Transportation and Biopharma to help pare debt.

However, I estimate GE's proforma debt of $59 billion would be about 6.3x last 12 months ("LTM") EBITDA. This would be considered at junk levels, in my opinion. The rating agencies likely gave GE a grace period for the company to get its $21 billion Biopharma deal done. That transaction was completed in Q1, yet what remains could be considered the dregs of the business. GE must now pare debt via cash flow, and that scenario is looking less likely.

S&P rates GE's debt at three notches above junk. It recently gave GE a negative outlook due to uncertainty over the pace of deleveraging. Management has had ample time to (1) rightsize power, (2) raise equity, or (3) sell assets to pare debt. GE's credit metrics imply the company is at or near junk status. Falling cash flow implies GE's credit metrics could deteriorate over the next few quarters. A ratings downgrade could be warranted.

Conclusion

A ratings downgrade could reduce GE's capital raising ability and hurt sentiment for the stock. Sell GE.

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.