General Electric Company's (NYSE: GE) recent moves to shore up its balance sheet by jettisoning GE Healthcare and refocusing on power, renewables, and aviation have certainly grabbed the attention of investors. However, it would be a mistake to ignore some of the more far-reaching, and arguably longer-term, changes that CEO John Flannery is planning. Let's take a look at them, and the key man that Flannery is likely to lean on while he implements them.
GE's future lies in renewables, power and aviation. Image source: GE Reports
GE's investor update
I think there are three key new things to take away from the company update at the end of June.
First, investors who believe in Flannery's turnaround plan but are concerned that the company's deteriorating balance sheet and near-term earnings and cash flow outlook will hinder Flannery's ability to enact it should be satisfied by the overall announcement. GE now has a clear plan for reducing debt, and it's on the back of one of its highly prized healthcare assets.
Second, it looks highly likely that GE will cut its dividend after the GE Healthcare separation -- and even if you include dividends from the new healthcare company, investors are still likely to receive less in aggregate.
Third, Flannery announced he would be downsizing corporate headquarters -- understandable now that GE is set to be a much smaller company -- and said that "we will run GE Company in a fundamentally different way going forward. Our businesses will be the center of gravity and will run on a new operating system that we believe will improve our operations and cash performance. These changes will reduce corporate costs by at least $500 million by 2020."
Why the cost-cutting matters
The last point should not be underestimated. Flannery previously promised a change in how the company would be run in GE's annual letter to shareholders in the spring, and reiterated the theme at the Electrical Products Group conference in May; but this was the first time he put a figure on the likely cost savings.
To put the figure into context, it's around $0.05 of GE's current EPS, and it's also the amount that GE lowered its 2018 power segment profit guidance by in the first-quarter -- it's not small beer, even for a company of GE's size.
Introducing Larry Culp
What's more, it's clear that former Danaher Corporation (NYSE: DHR) CEO Larry Culp is going to be a key man in overseeing the organizational changes. Flannery said, "I'm excited to work with Larry, and his experience fits extremely well with the changes we're making at the company."
You only have to look at a chart comparing Danaher's stock to GE's and those of its peers during the Culp years to get a sense of just how good his tenure at Danaher was.
In addition, the reasons why Culp did so well with Danaher are very similar to the reasons why he should be able to help Flannery do the same thing with GE. The secret to Danaher's business model lies in the so-called Danaher Business System (DBS). In a nutshell, it's a set of continuous improvement principles that embody lean manufacturing processes.
Culp would buy unloved businesses, bring them into Danaher, apply DBS, and raise their margins and returns on capital over time. A good example was Danaher's 2011 acquisition of Beckman Coulter: The company's margin and productivity were increased dramatically over the years.
While GE isn't going to be making any major acquisitions anytime soon, the best thing the company can do right now is improve productivity at its ongoing businesses, and Culp overseeing Flannery's execution is a formula that most investors should welcome.
What GE investors need to see
If Flannery is going to turn GE around and reduce debt levels as planned, then he's going to need to cut corporate costs overall while generating margin growth at the segment level. The task won't be easy, but with Culp on board GE has best-in-class advice on hand.
Moreover, if the new GE is structured in the manner of the old Danaher then it's possible that the company could finally realize the full value from servicing its huge installed bases of aircraft engines and power equipment. And that's something to look forward to.
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