The upcoming second-quarter earnings report from General Electric Company (GE 1.63%) will have investors eagerly looking for clues of any changes in strategic direction. However, the first thing management needs to do is reassure investors it's on track with its medium-term objectives. Keeping with that line of thought, let's look at three things investors need to hear from GE's management.
Cash flow
GE's first-quarter results disappointed the market from the perspective of cash flow. Industrial cash flow from operating activities (CFOA) came in $1 billion below expectations. The shortfall was due to a combination of factors, but management sees many of the problems rectifying themselves in the coming quarters. Indeed, guidance for full-year industrial CFOA of $12 billion to $14 billion remained in place.
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"We think CFOA is going to be sequentially much better in the second quarter than the first," CFO Jeff Bornstein said on the earnings call. "And we would expect year-over-year CFOA to be better through the half, equal or better to the half."
Clearly, GE is under pressure to deliver on cash flow in the quarter, and investors should look out for the specific issues identified from the shortfall in the first quarter:
- $200 million cash to be collected on invoices in aviation, and another $200 million in delinquent accounts. The former is expected to be collected in the second quarter; collection for the latter is unspecified.
- $100 million worth of inventory built up in healthcare because of weakness in the U.S. healthcare market.
- A $300 million shortfall in contract assets. Bornstein expects CFOA to catch up as contracts are executed.
All told, GE needs to convince investors these issues are being cleared up and that its CFOA is still on track in 2017.
Image source: GE Energy Connections
Power problems
Readers already know there are question marks surrounding GE's power segment in 2017. The forecast is for a flat 2017, and it's not certain whether its issues are cyclical (weak end-market demand, resulting from macroeconomic matters and coming particularly from emerging markets) or structural (slowing demand for GE's profitable E- and F-class gas turbines).
Moreover, a large part of the shortfall in CFOA in the first quarter was down to the power segment, with $200 million uncollected on invoices and a failure to close some big power orders.
As such, GE's power equipment orders and cash collection will be closely followed, as will management's outlook for the rest of the year in power.
Oil and gas -- always oil and gas
Weak energy capital spending created significant headwinds for GE in 2016. In fact, weaker-than-expected oil-and-gas spending was the main reason the company missed its original targets for revenue growth last year. Moreover, at a conference in the spring, outgoing CEO Jeff Immelt appeared to back off the company's target for $2 in operating EPS in 2018 and sounded cautious about the outlook for oil and gas spending -- particularly relevant because of the Baker Hughes merger.
It's all somewhat disappointing, because 2017 is supposed to be the year when headwinds in oil and gas turn into tailwinds in line with improving rig counts.
US Rig Count data by YCharts
GE's oil and gas outlook is, in fact, improving. Oil and gas equipment orders were up 30% in the first quarter. But this sort of performance needs to be replicated if the company is going to have any chance of hitting the $2 earnings target in 2018.
Looking ahead
There's always a lot going on when GE reports, but cash flow is likely to be the key focus. Essentially, management needs to convince everyone that its revenue isn't being boosted by activities that are weakening its CFOA generation. Meanwhile, clues to the near- and long-term earnings potential of two of its four core segments -- power, and oil and gas -- will come from the numbers and outlook.
With new CEO John Flannery's tenure beginning in August, investors will hope the second quarter will set him up for a trouble-free opening to his leadership of the industrial giant.
