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GE Power Problems Getting Worse, but Culp's Moves Give 5 Causes for Hope

Lee Samaha, The Motley Fool

General Electric Company's (NYSE: GE) recent earnings were disappointing enough, but the best adjective to describe the power segment performance is shocking. GE Power's performance in the quarter was even worse than most had expected, and definitely a lot worse than CFO Jamie Miller's previous commentary implied it would be.

That aside, there are some positives to be drawn from the earnings presentation. Let's take a look at what happened, and why investors have some reason for hope.

GE Power's weakening end markets

There's little doubt that the gas turbine end market worsened in 2018 and consequently it was always going to be a push for GE to meet its full-year guidance. Frankly, the numbers never looked realistic, and the analyst consensus EPS figure was notably lower than the low-end of guidance well before the third-quarter even began.

Meanwhile, its key rival in gas turbines, Siemens AG (NASDAQOTH: SIEGY), painted a grim picture of the power markets for the next couple of years while guiding its power and gas margin down. 

Moreover, GE's management itself noted weakening conditions. For example, GE was planning for gas turbine end demand of 30 gigawatts to 34 gigawatts in 2018, only for former CEO John Flannery to tell investors that the market was trending below 30 gigawatts during the second-quarter earnings call.

Furthermore, those of us who keep an eye out for these things noted that company guidance for gas heavy-duty gas turbines and aeroderivatives (small turbines) equipment sales were in decline.

Full Year Unit Shipment Guidance

July 2018

 April 2018

Jan. 2018

Nov. 2017

Heavy Duty Gas Turbine

50

50-55

60-70

65-75

Aeroderivatives

30

20-30

30-40

N/A

Data source: General Electric presentations. Author's analysis.

GE's results were horrible

Unfortunately, the grim reality hit home in the third-quarter. Going into it, CFO Miller had talked up the possibility of a better second-half by arguing that "In total, services revenue should be stronger in the second half" and on transactional services "We expect to see improvement in the second half, especially as we move into the fourth quarter." For reference, improving the profitability of its transactional services is a key focus of management efforts in 2018

Fast forward to the third-quarter and here are the shocking numbers:

GE Power

Q3 2018

Q2 2018

Q1 2018

Revenue

$5,739 million

$7,579 million

$7,222 million

Profit

($631 million)

$421 million

$273 million

Margin

(11%)

5.6%

3.8%

Data source: General Electric presentations.

In short, Miller acknowledged that "our previous forecasts were overly optimistic on the timing and the level of deal closures on heavy-duty gas turbines and particularly on aeros." Power services revenue declined 4%, with transactional services down 12%. 

When asked about the details behind a $631 million loss in GE Power in the third-quarter by Wolfe Research's Nigel Coe, Miller disclosed that GE had "$240 million of charges" relating to the blade turbine failure issue.  

She then said, "We saw about $400 million of project reserves and other execution issues and about $150 million of just some other execution issues," without going into any detail on the issues -- a staggering omission when you consider that the $550 million in "execution issues" represents 28% of the previous profit guidance.

Europe at night.

GE Power has problems, but the World still needs electricity. Image source: Getty Images.

Sources of hope

The results were far worse than expected. However, there are some positives from the presentations.

First, Culp's refusal to give guidance amid talking of giving numbers "with conviction and confidence" is a sign that he's determined to restore credibility with investors.

Second, there's a sense that the "other execution issues" in the GE Power profit & loss sheet for this quarter could be management throwing the kitchen sink into the numbers in order to start underpromising and overdelivering in the future -- something Flannery/Miller never did.

Third, the plan to split GE Power into two units (gas equipment and services in one unit, with the rest in another unit) should make it easier to sell or maybe partner one of the units, and it will also create transparency on any underlying improvement in power services. 

Fourth, in addition, the blade turbine failure issue looks likely to be temporary in nature and it should drop out of results in the future. 

Fifth, Culp will continue restructuring GE Power. Similarly, Siemens has also been significantly restructuring its gas turbine business and has been seen as willing to sell its gas turbine business. This is good news for GE, because when the leading players in an industry reduce capacity its usually good news for margins in that industry.  

The investor takeaway

All told, GE has a highly regarded CEO at its helm now, and the early signs are that he's not going to repeat the mistakes of Immelt/Bornstein/Miller in giving inadequate guidance.

That's a step in the right direction, and it will allow investors to make decisions on buying/holding GE stock based on numbers that they believe in. GE stock now deserves a closer look. 

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.