The fact that GE Power was the featured segment in General Electric‘s (NYSE: GE) the second quarter is significant. That says a lot about CEO Larry Culp’s impact on the business since October 2018. Segment performance was the culmination of a quarter that contained a lot of good news and a few flaws that need to be watched. Yet GE remains on track. Here is the truth.
Free cash flow orientation
By now, most investors, and certainly GE management, know that the market depends on the performance of GE’s free cash flow (FCF). The good news is that investors got what they wanted. The FCF reached $ 383 million in the quarter, as the latest public statements from management suggested there would be $ 400 million exit.
The better-than-expected performance led management to increase its forecast of industrial FCFs for the full year to a range of $ 3.5 billion to $ 5 billion, compared to previous forecasts of between 2.5 and $ 4.5 billion. That’s an increase of $ 750 million mid-term, which matches FCF’s “beat” in the second quarter.
Still, investors shouldn’t be too quick to conclude that all is well; there were some negative points during the quarter, particularly in the aviation and renewables segments. Meanwhile, electricity and health care delivered the bright spots.
At GE’s investor outlook meeting in March, management gave a forecast for the year 2021 that GE Aviation’s revenue would increase single-digit percentage with a margin in the low end. two digits. While management sticks to the margin forecast, CFO Carolina Dybeck Happe said she now expects annual revenue to be stable in 2020.
The reason? She blamed it on two things: first, a review of the non-monetary contract (CMR) margin of $ 400 million, two-thirds of which “was tied to a contract in a loss position”, and two, “of non-monetary contracts. Internal and external supply chain issues’ plagued by GE Aviation’s military business.
Interesting way, Honeywell also lowered its full-year aerospace segment revenue forecast due to “moderating defense spending in the United States” and “slower-than-expected international defense volumes,” according to Honeywell’s chief financial officer, Greg Lewis, on the call for results. It is not clear whether Honeywell and GE’s military business problems stem from the same source, but the weakness is worth watching at both companies.
Regarding CMR, Dybeck Happe said GE Aviation has around 200 contractual service agreements (CSAs) and “only a few” are in deficit. However, the $ 400 million charges taken on one of them during the quarter indicate continued tension in the aviation industry.
Overall, the aviation segment remains in recovery mode. However, as you can see in GE Aviation’s spare parts rate chart (my preferred primary indicator for GE Aviation), there is a long growth path ahead until GE returns to 2019 levels. .
GE renewable energy
Dybeck Happe has not adjusted the forecast for the segment, so investors can continue to expect single-digit revenue growth, improved margins and a generation of FCFs in 2021. On the other hand, she noted that a “long-term extension” of production tax credits (PTCs) would create some short-term uncertainty as they “delay investment decisions for what could be years.” In other words, customers might not rush to place orders if they know the PTC will be extended.
While this is not a problem for the industrial company in the long term, it is positive, and an extension of PTC could affect GE’s “second half order profile and positive free cash flow outlook for GE for the year. ‘year,’ according to Dybeck Happe.
Management now expects the segment’s profit margin to grow from 15.8% in 2020 to over 16.8% in 2021. This is compared to a previous range of around 16% to 16.5%. In addition, GE Healthcare is expected to have a good second half of the year with the economy reopening and the return of non-COVID-19 healthcare procedures.
As Culp noted, “It’s never going to be a high growth business for us,” but that doesn’t mean it can’t be a valuable FCF generator for the business. Indeed, Culp expects GE Power to deliver $ 1-2 billion FCF by 2023 – numbers that would mark a dramatic improvement over the minimum FCF generated in 2020.
According to Culp, the good news here is that gas-fired utilities are likely to “do better than these low single-digit incomes.” Meanwhile, Dybeck Happe has confirmed that GE Power is on track to meet its digital margin goal over time.
Indeed, as a sign that GE Gas Power is improving its service delivery, Gas Power CEO Scott Strazik has been promoted to CEO of GE Power as a whole. Additionally, GE Power’s overall margin was 7% in the quarter – a good sign.
What this means for investors
The potential problems with aviation and renewables appear temporary. So while travel restrictions could hurt GE Aviation and GE Renewable Energy could be affected by a PTC extension, they are both likely to be short-term problems at worst. In addition, these are two companies with good long-term growth prospects.
Meanwhile, GE Healthcare is in good shape and GE Power appears to be on its way to becoming a practical cash generator rather than a drag. For the long-term investor, the potential short-term turmoil in 2021 can be overlooked in favor of the positive underlying development of the company. As such, the GE share price is well positioned to improve.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.