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GE's Recovery Rests on Hopes Over Hard Math

Brooke Sutherland

(Bloomberg Opinion) -- There’s a light on the horizon for General Electric Co., but you will be waiting a while for the company to reach it.

GE released its much-anticipated 2019 outlook on Thursday, saying it expects to burn as much as $2 billion in cash across its industrial businesses this year before that all-important number swings “well into” positive territory in 2020 and the turnaround accelerates in 2021.

Recall that CEO Larry Culp said on the company’s fourth-quarter earnings call that cash flow would “grow substantially” in 2020 and 2021, without telling investors what the starting point was. We now know it will be a negative number – but it still remains unclear what exactly constitutes a meaningful improvement in the minds of GE management. These vague directional terms give GE plenty of wiggle room, and it appears it will need it. While GE’s cash flow should certainly improve in 2020 relative to the substantial cash burn it’s looking at for this year, the overall level appears likely to remain weak relative to the past.

This raises questions about whether GE can meet the cash goals that Moody’s Investors Service is baking into its credit calculations. The credit-rating firm released a report in February highlighting sources of funds that GE could tap to lower its debt load. This included $4.2 billion of post-dividend free cash flow over the course of 2018-2020, excluding contributions from GE’s stake in the Baker Hughes Energy business. With 2019 industrial free cash flow now at risk of being substantially negative, GE would need a material step-up in 2020 to hit that number. And it’s not clear how it will do that.

The buoyant stock reaction on Thursday is a testament to the long leash investors are willing to give Culp and their jubilation at a lack of material new surprises. But the numbers point to company that remains far away from a fundamental recovery.

This year’s cash hit will be driven by a number of factors, including an aggressive restructuring of GE’s power unit, the unwind of its GE Capital financing operations and legacy issues from its disastrous acquisition of Alstom SA’s energy assets. Many of these negative hits won’t repeat or will lessen, according to the company. Even so, GE expects its power unit to continue to burn through cash into 2020, although significantly less than it will this year. Its renewable-energy division will be a drag both this year and next as the company fulfills a rush of pre-paid, tax-motivated orders. GE expects its core imaging and diagnostics business in its health-care segment to show free-cash-flow growth, but that won’t be enough to overcome the loss of cash flow from the divestiture of its biopharmaceutical business to Danaher Corp., Chief Financial Officer Jamie Miller said in an interview on Thursday. That deal is expected to close this year in the fourth quarter, and analysts estimate the business generates $1 billion in cash.(2) 

Importantly, these cash-flow numbers don’t include the impact of GE Capital, which isn’t expected to break even until 2021 and will require additional funding from the industrial parent in 2020 beyond the $4 billion GE is contributing this year. One possible counteracting factor from a credit point of view is GE’s disclosure that it may buy back some of its debt via a tender offer to take advantage of discounted prices.(1)   

GE’s credit ratings may be at risk, says Bloomberg Intelligence analyst Joel Levington, and he’s right based on a straight reading of the cash flow numbers. The question is whether Moody’s or investors will operate based on the math or based on hope. Right now, it appears to be the latter.

Moody’s in particular has in the past changed the goal line for GE. To a certain extent, I can understand that: investors want to pick up GE shares at the bottom, and everyone generally wants to believe in Culp as the company’s savior. The CEO on Thursday said that after 2021, he expects GE’s industrial businesses to generate cash flow “far in excess” of the $4.5 billion they earned in 2018. But if you start talking about 2021 or 2022 as the true turning point, that entails significant patience for a company that has already used up a lot of it, particularly given a murkier macroeconomic future.

Thursday was the first time I felt like Culp sounded confidently in command of GE’s sprawling, troubled businesses, and he may yet steer this ship through the crisis. While GE didn’t do away with the aggressive adjustments to its earnings numbers, it did make a point to more distinctly highlight the biggest swing factors, and the disclosure around the individual businesses’ cash flow was a step forward in the company’s quest to be more transparent. But there’s a lot of work left to do and plenty that can still go wrong.

(1) One thing that eases the math is that GE now estimates the divestitures of its industrial solutions, distributed power and transportation businesses will deduct $200 million in free cash flow relative to its 2018 numbers. Its previous $1.2 billion guidepost was affected by the timing of deal closures, but also the underperformance of assets that were being divested, which I don’t think should count as a victory.

(2) This is something GE's head of investor relations had written about as an option for deleveraging when he was still an analyst covering the company for UBS. Perhaps that's where it got the idea.

To contact the author of this story: Brooke Sutherland at bsutherland7@bloomberg.net

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

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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