General Electric (NYSE: GE) management finally gave specific guidance for 2019 and directional guidance for 2020 and 2021. The numbers and details discussed aren't likely to be significant game changers, but they'll change the way the bull/bear debate over the stock takes place. Let's take a look at the key details and takeaways from the presentation and what they mean for investors.
General Electric's guidance
Going into the presentation, it was already assumed that industrial free cash flow (FCF) would be negative in 2019 and the troubled power segment's cash outflow would get worse in 2019 before both sets of numbers registered improvement in 2020. The key question is, what kind of FCF can investors expect from GE after the reset year of 2019 is over? More specifically, what is the timing of the margin and cash flow recovery at GE Power?
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The good news from the presentation is that investors were given a lot more information on the matter. Here are the headline details from the 2019 guidance:
- Industrial revenues are expected to increase in the low-single digits to the mid-single digits.
- Adjusted industrial operating margin is expected to increase from zero to 100 basis points (where 100 basis points equals 1%).
- Adjusted industrial FCF is expected to be in the range of negative $2 billion to zero.
Obviously, no one wants to buy a business with negative cash flow -- especially one with net debt of $55 billion in its industrial businesses and debt of $66 billion at GE Capital . But as Culp outlined, this year is going to be a reset year with the first quarter marking the low point. Industrial FCF is set to be positive in 2020 and "the pace of improvement" will accelerate in 2021. This is what long-term investors should be focusing on.
Cash flow guidance
For a flavor of what to expect, here's the industrial FCF guidance given for GE's major segments in the next few years.
|2018 Free Cash Flow||2019 FCF (guidance)||2020 FCF (guidance)||2021 FCF (guidance)|
|Power||($2.7 billion)||Down||Significant improvement/negative||Positive|
|Aviation||$4.2 billion||Flat||Flat to growing||Up/Accelerates|
|GE Industrial||4.3 billion*||($2 billion) to 0||Significant improvement/positive|| |
Data source: General Electric presentations. Table by author. *Excludes dispositions. **Excludes biopharma.
Before turning to power, it should be noted that the two other major segments have near-term cash flow headwinds facing them in 2019. The key point, however, is that cash flow generation is set to improve in the coming years.
FCF in healthcare will decline in 2019 as it sold its the biopharma business to Danaher, but it's expected to improve on an underlying business in 2020.
Aviation revenue is set to grow by high-single digits in 2019, but a decline in the margin -- from 21.2% in 2018 to around 20% in 2019 -- will restrain earnings growth and lead to flat FCF performance. However, this shouldn't be seen as a negative because the margin deterioration is largely down to the ramp in LEAP production -- something that will lead to strong earnings and cash flow in future years as the engines are serviced.
Turning to power, the guidance doesn't look great overall. On the plus side, segment margin is expected to be positive in 2019, but unfortunately, FCF won't be positive until 2021 -- something that could cause credit-rating agencies to downgrade GE's credit rating.
There are three key conclusions. First, it's likely that it won't be until 2020 or possibly 2021 before GE starts to generate an FCF level that would put its stock on a price-to-FCF multiple currently comparable to its industrial peers. This is a concern because the company's earnings/FCF could be pressured by any marked slowdown in the economy.
Second, Larry Culp deserves credit for the transparency of GE's recent reporting and the candid nature of his commentary on GE. It's a significant improvement from the previous CEO's efforts.
Third, partly as a consequence of Culp's transparency, a lot of uncertainty has been removed, and now the debate will shift onto what kind of long-term FCF GE can generate in the future and how best to evaluate the stock. That's something that could favor the bulls, whose strongest case is that GE's underlying FCF rate is a lot stronger than what it will report in the next couple of years.
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