A Big Turnaround At General Electric Is Taking Place

The management team at General Electric just announced financial results for the third quarter of the conglomerate\'s 2019 fiscal year.

While there were some negatives in the report, the overwhelming majority of it was a sign that a turnaround is happening.

Investors should embrace these developments as positive and act accordingly.

For most of 2019, many market participants have feared that a turnaround at industrial conglomerate General Electric (GE) either wouldn’t take place at all, or that it would take far longer than desired. Even earlier this year, I made the case that investors who are bullish the firm should plan to be in it for the long run or not at all, since a short-term recovery was improbable. Now, though, through the hard work of management and thanks in part to robust orders at select parts of the firm, the situation is clearing up. While a true recovery is still some time off into the future, there appears little doubt now that General Electric’s worst days are behind it.

*Taken from General Electric

For a firm as large and complex as General Electric, the key to ensure a successful turnaround is to maintain steady progress. This is precisely what management has demonstrated the ability to do this year. As you can see in the image above, for instance, the goalposts continue to move at the firm, but for the better. In March of 2019, for instance, management said that investors should expect Industrial free cash flow this year to be between -$2 billion and $0. Later on, this shifted to a coin flip between positive and negative cash flows, while now, in its third quarter earnings release, the firm expects this figure to be between $0 and $2 billion, completely flipping guidance compared to March.

*Taken from General Electric

There are several reasons behind this improvement. One such contributor appears to be a reduction in cash costs associated with the firm’s restructuring. These costs, earlier this year, were forecasted to be as high as $2 billion, but this has since been reduced to around $1.3 billion. Another contributor, as the image above illustrates, appears to be a rapid improvement in the firm’s Power segment. Last year, free cash flow associated with that segment was -$2.7 billion (-$2.3 billion if you factor in certain structural changes to the segment). This year, the belief was that the segment would see cash flow come in lower, but management’s efforts on reforming the business appear to have warranted a different change. This year, instead, the goal for Power is to see cash flows come in flat.

While revenue for the company’s Power segment is down some year-over-year, management has boasted a significant improvement in fixed costs for the business. These have dropped, in the three quarters seen so far this year, by $0.23 billion. This has helped the segment’s loss narrow from $676 million in the third quarter last year to $144 million today. Perhaps the only major negative for the segment was that its orders in the latest quarter were only $3.86 billion. This is not only lower than revenue for the quarter, it’s below the $5.52 billion the segment saw in the third quarter last year.

Power has been a mixed, but generally positive, bag in this quarter. Other segments have been more robust. Aviation, General Electric’s crown jewel, for instance, saw revenue come in at $8.11 billion, up 8% over the $7.48 billion seen in the same time last year. Although orders did come in weaker at $8.80 billion versus last year’s $9.13 billion, they still were higher than revenue and the segment boasted a profit of $1.72 billion. This implies a bit of a margin contraction from 22.3% in last year’s third quarter to 21.2% today, but the bottom line is still, nominally speaking, higher than 2018’s $1.67 billion.

It should be mentioned that, this year combined, the company’s cash flow has already been impacted by $1 billion due to the 737 Max outage. This will prove to be a problem in the fourth quarter, likely costing the firm another $400 million in delayed cash flows. Renewable Energy, meanwhile, reported strong revenue of $4.43 billion, up from $3.92 billion last year, and strong orders at $5.02 billion compared to $3.86 billion in 2018. However, its loss of $98 million was painful compared to its gain last year of $116 million. As the segment works through some poorly-priced legacy wind projects, this bottom line should improve, but the segment is unlikely to be a cash cow anytime soon.

*Taken from General Electric

Besides turning around problem segments and making the best of quality segments, one key thing General Electric must do to fully recover is to unwind non-core parts of itself. So far this year, between its ownership in Baker Hughes (BKR) and Westinghouse Air Brake Technologies (WAB) (a.k.a. Wabtec), the firm has already brought in cash through the third quarter worth $9 billion. As part of its Baker Hughes divestiture, the company did see a non-cash hit to its earnings, reported in discontinued operations, in the amount of $8.7 billion during the third quarter (which was larger than I anticipated), but the important thing now is working to reduce leverage. Thankfully, the rest of this year should be kind to the business. Management said that its BioPharma sale is still in the works. That alone will bring in $20 billion in estimated proceeds. As such, during the fourth quarter, it looks like General Electric will see asset sales of $29 billion on top of what was already closed earlier this year.

*Taken from General Electric

Finally, we have two last selling points: backlog and organic revenue. Due in large part to strong awards at the Paris Air Show, total backlog across the entire conglomerate grew to $386 billion. This represents an increase of 14% year-over-year if you adjust for asset divestitures. That’s all future revenue just sitting on the books that will be realized over the next several years. Revenue itself, at the firm’s Industrial set of businesses, grew 7% organically during the quarter as well, thanks largely to Aviation and Renewable Energy. While I do expect some recovery of the firm’s Power segment to take place over the next two years, these other two segments will continue to be the strongest revenue drivers in the long run.

Based on the data provided, I have to say that I don’t have any material complaints regarding General Electric and its latest quarter. Sure, there were some bad spots, but that’s to be expected with such a large, complex entity. The most important thing is to see a general improvement in most categories, and that’s precisely what we experienced. Moving forward, it looks likely this trend will continue and I believe that investors would be wise to consider the conglomerate as a prospect, but only if they are willing to hold on to what will be a long and bumpy ride.

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.