It hasn't been a great year for shareholders of General Electric (NYSE:GE), who have watched as the stock hassignificantly underperformed the S&P 500. Now, CEO Jeff Immelt is under pressure to reassure the investment community that the company is back on track toward its earnings and operational goals, and he sought to do just that with his presentation at the Electrical Products Group conference last week. Let's take a closer look at the key takeaways from the presentation.
1. The target of $2 in operating EPS by 2018 will be tough to hit
Frequent readers of the Fool already know that Immelt's target of $2 per share in operating earnings by 2018 is looking like a stretch; his comments at the presentation reflected the work GE would have to do in order to hit that target. In a nutshell, he said that the $2 target was "at the high end of the range, and our job now is to take more cost out." Moreover, he added the caveat that the forecast range assumes stable resource markets.
While Immelt obviously hasn't abandoned his operating EPS goal, it's clear that he knows achieving it will be far from a walk in the park.
2. There are new objectives to focus on
Immelt redirected investors toward a set of objectives against which they can benchmark GE's progress. Both during the main presentation and the question-and-answer session, he reiterated his expectations for 2018:
- Organic revenue growth in the range of 3% to 5%.
- Operating margin expansion of 100 basis points.
- Free cash flow conversion from net income of 80% to 90%.
Regarding all three of these objectives, there are considerations to be made. For example, GE missed its initial organic revenue growth expectations in 2016 as its oil-and-gas-related sales growth was a lot weaker than initially expected. Moreover, there are question marks on whether its power business is facing structural problems.
3. Cost-cutting will be key
Implicit in the expectation for margin expansion is the idea that GE will cut product costs. Immelt outlined "a couple of big levers" with which GE can increase margin. Specifically, he discussed GE's H-turbine and the LEAP aircraft engine -- "[two] of the biggest launches in the history of the company" -- and how production increases would lead to falling unit costs.
For example, Immelt outlined how an H-turbine's unit cost fell 30% in 2016 and is projected to fall another 10% in 2017, while the unti cost for the LEAP engine (part of a joint venture with France's Snecma) declined 20% in 2016 and is projected to fall another 15% in 2017.
Cutting costs is clearly a vital objective, as Immelt disclosed that equipment margin had dipped to just 1% in 2016, compared to a historical rate of closer to 5%.
4. So will cash flow generation
This is a subject of immediate concern for GE; its cash performance in the first quarter was disappointing and indicative of a company facing difficult trading conditions. That said, Immelt reiterated expectations for industrial cash flow of $12 billion to $14 billion in 2017, and going forward, free cash flow conversion from net income is intended to be in the 80% to 90% range.
Discussing the matter, Immelt said: "I view 2017 as really the last big restructuring year in the company. So this noise is going to kind of come out of the system." His argument is that the large product launches (such as LEAP and H-turbine mentioned above) and Alstom energy assets integration are using up cash, but cash flow generation would get better going forward.
5. The troubles of the oil and gas sector are still a concern
One of the criticisms leveled at Immelt is that he was late to the oil and gas party, and then overpaid for a collection of businesses just ahead of a downturn in fossil fuels. Indeed, last year, GE's oil and gas business delivered a disappointing performance.
As Immelt noted, to hit the $2 EPS target, GE needs resource markets to remain stable. "Again, we've seen, I would say, the oil and gas markets stabilize," he said. "We see orders improving, but it's off a low base. So I still think we have to underwrite caution in that space."
Where to next for GE?
Overall, Immelt appeared to be backing away from his target of $2 operating EPS by 2018, and instead guiding investors toward another set of objectives that GE could largely achieve through internal execution (unit cost production cuts, increased cash flow), but that remain contingent on end-market conditions -- particularly in the oil and gas sector.
It was a slightly disappointing, but not completely unexpected, presentation. On a positive note, it may well have reset investor expectations. Clearly, though, GE has much work to do in 2017.