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GE Adds Another Page to Its Turnaround Story

Brooke Sutherland
·5 min read

(Bloomberg Opinion) -- General Electric Co.’s turnaround is back on track.

The industrial giant on Wednesday reported a surprise marginal profit for the third quarter and positive free cash flow of $514 million. Analysts had been bracing for another period of decline after GE burned through more than $4 billion in cash in the first half of the year amid a drastic slump in its top-performing aviation unit because of the pandemic. One big reason they were expecting a drop? GE’s own commentary and the decision to lower the bar on a big equity award for CEO Larry Culp seemed to signal a recovery was being pushed further out.

GE Upbeat Cash View Clashes With CEO Pay Deal

Even in mid-September, when Culp did finally signal a halt to the free-cash-flow burn this year, he appeared to indicate the fourth quarter — not the third — would be the turning point. If the goal was to underpromise and overdeliver, GE succeeded: On a day when the broader market was swooning, the company’s shares climbed as much as 10%.

“This is a period of great uncertainty,”Culp said in an interview on Wednesday. “It’s prudent to be conservative yet realistic in an environment like this.”

GE’s better-than-expected cash flow performance in the third quarter stems from improvements in working capital dynamics like inventory management and at the beleagured power division, which eked out a small operating profit in the third quarter. This business had been the focus of Culp’s turnaround efforts before the pandemic hit, and it appears his efforts to inject more operational discipline are starting to pay off. Cost cuts across the company in response to the pandemic are also starting to yield benefits. This includes a plan to eliminate 13,000 jobs — or 25% of the workforce — in the aviation unit. Unlike rival Raytheon Technologies Corp., which expects about half of the 15,000 people cut from its commercial aerospace divisions to return as volumes recover, Culp said the bulk of GE’s targeted cuts are expected to be permanent. That could bolster profit margins down the road, albeit at a material human cost.

GE on Wednesday reiterated its forecast for positive industrial free cash flow in 2021, which now seems more achievable. The company expects to generate “at least” $2.5 billion of cash flow in the fourth quarter. Given GE’s track record on forecasts, it seems likely that this too may be an undershoot.

A material outperformance may come down to the aviation unit, which appeared to be stabilizing in the third quarter but at a very low level. Orders were down more than 50% compared with the year earlier and profits were down nearly 80%. GE did flag some incremental improvements, but the emphasis is on the incremental: The percentage of its engine fleet that is parked is now about 26%, compared with 31% at the end of the second quarter, and lucrative maintenance shop visits are trending down about 50%, compared with 55% as of July. With this business driving so much of GE’s cash flow and profits, the inevitably slow recovery will remain a pressure point. “We’re not taking any departure for granted,” Culp said, acknowledging rising coronavirus cases around the world risk crimping the fledging recovery in air traffic.

Dark Time for Aviation Is About to Get Darker

Separately on Wednesday, Boeing Co. said it would cut an additional 7,000 jobs, bringing this year’s reductions to 30,000, as demand for new planes remains low and cancellations pile up for its still-grounded 737 Max. That affects GE, too: in a filing Wednesday, the company said customers have canceled 1,100 orders for the engine that powers the Max this year.

But the problems in the aviation industry aren’t new, and GE kept the fresh bad news elsewhere in the company to a minimum. It completed the annual GAAP-based stress-testing of its reserves for a run-off insurance arm in the quarter, and for once trends in this business went GE’s way. The lower-for-longer interest rate environment was a drag on expected returns for investments that fund the reserves. But the pandemic has been particularly precarious for the older individuals who own long-term care insurance policies issued by GE and has made people reluctant to enter the kind of care facilities that generate many of the claims on those policies.

GE Is Still Haunted by '$15 Billion Problem'

GE also said it was setting aside $100 million in relation to a Securities and Exchange Commission investigation into its handling of a surprise $15 billion funding shortfall in the insurance business, long-term maintenance agreements and a large goodwill writedown in the power unit. SEC staff earlier this month warned they may recommend civil penalties over the insurance issue without specifying any decision on the other matters. If the worst of any action from the SEC is a $100 million penalty, that will be good news for investors. Some had worried the SEC would require earnings restatements or a restructuring of the GE Capital arm to isolate the insurance business and its funding. Asked on the earnings call how GE arrived at the $100 million number, Culp reiterated that the company is cooperating with the SEC and said the reserve reflects “our view of what’s appropriate under the circumstances.”

All in all, this was a good showing for GE, even if the bar was low. There is still a long way to go for the stock to get back into the $17 range that would get Culp the full amount of his equity award (and help shareholders recoup at least some of their losses). But Culp has earned every right to proclaim that “GE’s transformation is accelerating.”

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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