General Electric Company (NYSE: GE) CEO John Flannery's presentation last week at the Electrical Products Group (EPG) conference certainly caused a stir in the stock price, sending it down more than 7% on the day. However, it's a good idea to take a step back and reflect on what Flannery actually said. Here are three key takeaways based on what he outlined, and none are particularly good.
Turning around the power segment remains the key to General Electric's prospects. Image source: Getty Images.
1. General Electric's 2018 guidance is under pressure
To be fair, Flannery maintained full-year EPS guidance of $1 to $1.07 and free-cash-flow (FCF) guidance of $6 billion to $7 billion. And he reminded investors that GE expects to be at the low end of the EPS range. Similarly, he reasserted that GE was "ahead of plan" in its target of cutting $2 billion in costs in 2018 -- nothing new there. And the remark that seemed to get the most media attention -- that power profit would be flat at $1.9 billion in 2018 -- is old news from the first-quarter earnings presentation.
So what was new?
For the first time since the November investor update, GE revised its standing guidance for the aviation and healthcare segments, the bright spots in its collection of businesses. This is important because GE's management expects the two segments to offset a weaker outlook in power -- the guidance for $1.9 billion in operating profit for power in 2018 (given on the first-quarter call and repeated by Flannery at EPG) is actually a reduction of $500 million from the implied guidance given in November.
However, as you can see below, the implied guidance for the three key segments is still significantly below my interpretation of the guidance given in November. In other words, what Flannery predicted for aviation and healthcare won't be enough to fully offset the reduction in power guidance of $500 million. Put simply, the update suggests there's more pressure on GE's earnings guidance for 2018 -- analyst consensus is below the bottom of the $1 to $1.07 range at $0.94.
2018 Estimate at November Investor Update
|$6 to $6.25 billion|
$3.64 to $3.7 billion
Data source: Company presentations. Analysis by author. *Using midpoint of guidance.
2. The power outlook
Stabilizing the power segment is the single most important thing GE must do for its investors, so any update on management's outlook will be keenly watched. Going back to the outlook given on the first quarter, management said it was planning for a heavy-duty gas turbine (HDGT) market of 30 gigawatts to 34 gigawatts in 2018. However, as already noted, GE has cut its 2018 power-segment profit outlook by some $500 million in response to HDGT end markets, which were trending below 30 gigawatts in the last six months.
There were two key pieces of information from Flannery's power outlook:
- GE still expects 30 gigawatts to 34 gigawatts in HDGT end demand in 2018, but is planning for a market below 30 in 2019 and 2020.
- GE is aiming to get power segment margin back to a 10%-plus figure (no time specified), notably above the 5.6% achieved in 2017, but notably lower than the 11.7% in 2016.
It's no secret that the HDGT market is challenged, but GE's outlook implies the possibility of revenue decline in 2019. Turning to the issue of margin, Barclays analyst Julian Mitchell pointed out that GE had "talked before about a low- to mid-teens operating margin aspiration" rather than the 10%-plus figure discussed by Flannery at EPG.
3. The dividend outlook
J.P. Morgan analyst Steve Tusa asked Flannery whether he would "stand behind the $0.48 dividend in 2019 with what you see today and what's going on in the portfolio." In response, Flannery talked about the "importance" of the dividend to GE investors but also said the dividend is "ultimately a function of the free cash flow of the company. And that's ultimately a function of our operating performance with the assets and things that we do with the portfolio."
Of course, Flannery is only stating facts that most investors already know, but his qualified language can be taken as a sign that GE's dividend is not set in stone. Moreover, given that management's guidance for 2018 earnings (and by implication, FCF guidance) is under threat, it's fair to assume there could be pressure on GE to cut its dividend if its end markets turn down.
The bottom line
All told, it was a disappointing presentation. There isn't going to be a "quick fix" to the power segment according to Flannery, and the 2018 earnings guidance looks challenged. Demand for gas turbines has weakened, partly due to the increasing use of renewables for energy production and the falling cost of storage -- which in itself makes renewables more viable as an electricity source. It's a problem shared by key rival Siemens and it's far from clear whether it's a long-term structural problem or not.
In short, don't buy GE if you are an investor worried about the company meeting its near-term earnings outlook -- it looks like things could get worse before they get better for the company.
On a more positive note, Flannery outlined a pathway to margin expansion in the power segment -- even if it's not as good as previously hoped. And any kind of relative improvement in the HDGT end-demand outlook will see analysts scurrying to raise earnings guidance in the future.
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