General Electric's (NYSE:GE) shareholders have not been thrilled with the company in the last several years, and they're probably not too happy with its recent precipitous drop, either. But with a new CEO in charge, GE might be just now starting to turn that trend around.

In this week's episode of Industry Focus: Energy, host Sarah Priestley and Fool contributor Sean O'Reilly look through GE's last few earnings reports and explain what's been going wrong with the company. Also, they look at how new CEO John Flannery might change things around in a few huge ways, whether or not this week's drop could be a buying opportunity, and more.

A full transcript follows the video.

This video was recorded on Nov. 2, 2017. 

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, November 2nd, and we're going to be weighing in on GE and discussing the rumor mill around the November 13th announcement. Joining me in the studio is longtime host of the show and Motley Fool contributor, Sean O'Reilly.

Sean O'Reilly: Good morning, Sarah!

Priestley: How does it feel to be back in the studio?

O'Reilly: I was just thinking to myself, I have the headset on, I have the chair, I have my computer in front of me, and I got a flowy Zen state. Like, this is just like old times, this is great. It's like riding a bike.

Priestley: So, no yoga for you, just come to the studio.

O'Reilly: I do have to say, once again, the British accent is the greatest addition to this show. Like John Oliver is the best late-night comedy show, and although they do fantastic research, it's just the British accent.

Priestley: I think you're going to have people writing in contesting that. 

O'Reilly: Really? I mean, Dylan sounds fun, too, but ... [laughs] 

Priestley: So, today we're going to be talking about GE, as I said. Year-to-date, the stock is down 36.5%. So, there's some very annoyed GE investors. In the October report, GE had its first profit miss in two and a half years. The company cut full year earnings targets, and many analysts are speculating that a dividend cut might be coming soon. For some background check, if you're just getting interested in GE, it's been through a period of divestitures to refocus on its industrial core. In the past few years, they've sold off their real estate portfolio, while most of GE Capital sold home goods, which is dishwashers and appliances, and their media properties. More recently, they're selling their water business, their electrical equipment business, and now even the light bulb business is up for sale.

O'Reilly: They can't get rid of that.

Priestley: Edison is turning in his grave. Facing cyclical headwinds, particularly in the Power and Oil and Gas segment and causing investors to worry about cash flow. So, only three months into the job, new CEO John Flannery is facing pressure from activists Trian Partners and other investors to reduce costs. Flannery became CEO August 1st. What do you make his performance so far?

O'Reilly: We he went in there and cleaned house. I think for the first couple of months, he read up on every division and met with people. He did, unsurprisingly, because of his history in Finance at GE and at Healthcare, he expanded the gross margin a bit. We'll talk about that later. But, he's probably doing the necessary things. It's when we talk about the future that things get dicey. I think he's an awesome guy. I just wonder what the board of directors choosing him says about what everybody thinks the future of GE is.

Priestley: I think that's a very good point. I think he was kind of an underdog for the position, and there was a really interesting piece when they announced this, Immelt said that at one point, Flannery was in his doghouse.

O'Reilly: Oh my gosh. I missed that, what happened?

Priestley: I don't know. That's all he said. He said he's run five different businesses, or, he's been part of five different businesses, and at one point he was in his doghouse. So, for me, I think this speaks to the fact that people are looking for a change in culture.

O'Reilly: That's so interesting. If there's one thing that I would never question about Mr. Flannery, it's his loyalty to the company. He went to India. They asked him to go to India and Japan to start getting things going there. We actually don't know a great deal about the results that he got there. They talk it up. We don't have a ton of data or anything. But, he's been with them for 30 years. He's literally a company man. So, it's funny that she was in the doghouse. The loyalty is there, so what was the disconnect?

Priestley: Yeah, and it seems like he's gone in there with a really clear idea of what he wants to do. Like you said, he's cleaned house. There's been some executive moves. He wants to sell underperforming businesses, cut costs, and he's given Trian a seat on the board, which I guess is debatable. But, something he had said that I think is interesting, he says GE has a number of strong franchises, but other businesses drain investment and management resource without the prospect of substantial reward. So, he has laser focus on getting rid of those.

O'Reilly: It reminds you a little bit of what Jack Welch did back in the 80s. It's interesting, Flannery, like me, he's a finance guy. Welch, he has a degree in industrial chemicals or something. You're the industrial girl. He's technically a scientist from college, but he worked his way up through the ranks, from a chemical engineer to something. But, he went in there and was like, "If we're not No. 1 or No. 2 in a market, we're selling a business." And he sold a ton, and plowed that money into stuff. Time will tell, but yeah.

Priestley: I think you're right. I think that could be his intention. I think something that I really like about him is he has skin in the game. He bought $2.7 million of stock shortly after becoming CEO.

O'Reilly: That's a chunk of change.

Priestley: We don't know, that could be loose change to this guy. But I like seeing CEOs put money where their mouth is.

O'Reilly: For sure.

Priestley: He's saying a lot of the right things about cutting corporate expenses. The jets have taken up a lot of media time.

O'Reilly: [laughs] I read it on the way in, there were like, 700 company cars that executive could use. I was picturing, 700 cars, did they just have a giant parking garage? A giant parking structure somewhere? [laughs] 

Priestley: And ironically, that wasn't the worst thing. But I think a lot of these have been exaggerated. But, the very fact that he's addressing this small, low hanging fruit is a good sign. It's a good sign of a change in the industry. You touched on Healthcare, we have slightly different views on this. I think that in two years, which is a very short time --

O'Reilly: For sure.

Priestley: -- in a leadership position, he did make an impact. He delivered organic growth, which for a mature company, is kind of rare. But yeah, what do you make?

O'Reilly: You remember when I called in, it was the first or second episode that you took the reins. Taylor Muckerman was here, and Muckerman contributed to the Baker Hughes discussion, which, a lot of GE's future is tied to this. And everybody would look like a genius if oil prices double tomorrow. That's the other fun part about all of this. Anyway. Every press release, every interview, everybody, the first thing they talk about with Flannery was his GE Healthcare performance. I wish I knew about their diagnostic machines. I don't. I've got Market Share data here, but we don't know how tough that business is. I don't know if they just need more sales people to get hospitals to buy these things. We don't know how hard it was. Nevertheless. Everybody talked this thing up. And profits went from, I think he took the reins in spring 2014 or something, then you have to get a handle on things. But, margins were up 100 basis points, as you mentioned. Revenue for GE Healthcare went from $18.3 billion, and then they stayed flat. But then comes to margin expansion. Operating profits for the division in 2014 were $3 billion. They dipped in 2015 to $2.9 billion, which is kind of like, OK, what's going on there. Then it rallied to $3.2 billion. But over that same timeframe, I got, ha-ha, Aviation. I had to, because I'm with you.

Priestley: It's my favorite.

O'Reilly: Revenues for that division, 2014, they go to $24 billion, they go to $26.3 billion, and then profits for that division, this was awesome, up 25% over those two years, $5 billion to $6.1 billion. So, everybody was calling them out as this awesome manager, and he cut costs and saved or whatever. But the growth was not there. It was literally flat, $18.3 to $18.3 over 2015 to 2016. Profits, it rallied a little bit. Again, we don't know how hard it is to sell these diagnostic machines. This is not exactly gum. You only buy a machine for 20 years.

Priestley: Yeah. And I would say, the 2015 results were probably somewhat instigated in 2014 when he wasn't there.

O'Reilly: For sure.

Priestley: So, I think people saying that he improved margin and everything else, a lot of people are probably taking the 2015 to 2016 stats. And I do think it's a very short amount of time to be in leadership. So, people are probably clutching at straws a little bit, but I think you can read some positive signs in there. The recent results for GE, in case anybody has missed it, they missed estimates. They were meant to get $0.49 per share and came in at $0.29 per share. They incurred huge restructuring charges. At first glance, their revenue was up 10%. But as you mentioned earlier, the Baker Hughes merger really contributed to that. If you take that out, it would have been flat. The equipment segments revenue climbed 10%, power business profit caved 50%. So, all of this basically generated a lot of concern over cash flow. GE is such a huge company, it has good cash flow but not good enough. If you look, they had a target of $12 billion for the year. This has fallen to $7 billion. They have a historical capex of $4 billion. The problem being, dividend payments run $8.8 billion.

O'Reilly: You had to feel bad for him on the conference call. I think the first words out of his mouth were, more or less, unacceptable or something.

Priestley: Yeah, he apologized for the results.

O'Reilly: You had to feel for him. It's like you mentioned with Healthcare. The results that we just witnessed, he didn't do that, at all.

Priestley: Yeah. And incoming CEOs have to deal with this a lot. But, I like the approach that he took. He seems very much investor focused. He actually said he had a history of focusing on what the investor wants. However, a lot of investors believe the stock is a blue chip, safe 4.5% dividend yield.

O'Reilly: Founded by Thomas Edison!

Priestley: Exactly, a 125-year-old business. And it's likely, I believe, that they're going to cut that dividend.

O'Reilly: Yeah, I was reading on the way in, forgive me, I think Jeremy Bowman at The Fool wrote it, but he pointed out that in the conference call, what did he say, they have to balance the dividend with their growth initiatives.

Priestley: Yeah, and I think that's sensible.

O'Reilly: For sure. But, if your dividends guy, I mean, everyone went nuts. The stock fell 13%.

Priestley: Yeah. It's the worst performance since the Great Recession in one week.

O'Reilly: [groans] And they had the Finance arm then. [laughs] 

Priestley: It's not as terrible as people think, because they have a lot of cash on hand. They could finance this. The thing is, there's such a change in attitude. Jeff Immelt said dividend was sacrosanct. He said cutting it in 2009 was the worst day of his tenure. Yet, Flannery has come in and said, there are no sacred cows. Capital allocation is an emotionless decision. As you said --

O'Reilly: Which is awesome. Anybody who says that, you want.

Priestley: Exactly. When you get companies this big, this mature and hard to grow, I think you need somebody to come in and make the tough choices.

O'Reilly: Right, like getting rid of all those jets and cars and stuff.

Priestley: Yeah, exactly. So, we're going to hear about the potential with the dividend on the November 13th meeting. There's been a lot of rumors around it. But, what are you looking for when they announce?

O'Reilly: It depends. You could do the ExxonMobil route. We've had this downturn in the oil sector for a long time. Is it the three-year anniversary this Thanksgiving? We called it with Crowe and Muckerman, the Thanksgiving Day Massacre, OPEC refused to cut production in 2014. But, ExxonMobil has kept up their dividend. I think that used literally the same words, sacrosanct, that we're going to do this. Their balance sheet is so big. You issue debt, you have a little cash flow, it's fine, and you ride it out. I'm of the opinion that, in order to really get things going for GE and be here in another 125 years, I need to go all in on the innovation and growth. You look at Google, for example, I think they make $26 billion, and they spent $12 billion on R&D. That actually borders on irresponsible. That's a lot of money. There's all these moonshots. GE, market share, they're No. 2 in the world for making wind turbines, for example. That business, how many wind turbines were there 20 or 30 years ago? They need to be doing more of that in order to really maintain this leadership position in corporate America and the world. Let's just face it, things are changing. It's faster now.

Priestley: You actually said this earlier, you made the an analogy with Jack Welch talking about how he used to sell the big companies in order to fund some of these ventures. And that's possibly something we could see. Flannery plans to sell about $20 billion worth of businesses. 

O'Reilly: That's walking around money. [laughs] 

Priestley: Yeah. On the chopping block is the transport division, I think that contributed $4.7 billion of total revenue of $124. And then, the Healthcare technology segment, which is Centricity. I actually don't know much about Centricity.

O'Reilly: I wish.

Priestley: That's also potentially going to be up for sale. So, we might see some of this legacy plan that used to be inactive revisited. But, we're certainly going to see a new operating process put in place. We're also going to see a change in how they communicate to investors. I don't know if you've seen any of this, but the SEC sent them a commentary note to say they're kind of irresponsible and how they present to investors.

O'Reilly: This is the old story about GE's creative accounting.

Priestley: Absolutely. It's Jeff Bornstein, right, the ex-CFO.

O'Reilly: He's out now, right?

Priestley: He is out, and understandably, I think if you take into consideration the fact that Immelt confirmed the guidance last December of, what was it, $2 a share?

O'Reilly: The number, the number $2.12 popped into my head for some reason but I have no idea...

Priestley: Well, they're going to miss it by about 50%, so it is irresponsible. And I think that use a lot of terms that aren't generic in the industry. For example, their non-gaap core EPS is worded as "industrial operating plus verticals/EPS."

O'Reilly: Say that five times fast, right? Everybody worships Jack Welch. And he did some things there that were very admirable. But the bottom line for that man was, as I understand it, EPS growth, earnings-per-share growth. And any investor that's starting to learn about accounting, earnings per share is this wonderfully creative --

Priestley: Fudgeable. [laughs] 

O'Reilly: -- fudgeable, gaap-y thing. I can't even say what you just said, plus vertical ... why?

Priestley: The good news is, the incoming CFO, Jamie Miller, she's promised to go back to basics and revisit --

O'Reilly: Finance 101.

Priestley: Yeah, so that's perfect.

O'Reilly: I do have to ask you since I have you here -- I'm going to play host for a second -- what did you guys at Rolls-Royce, what was the opinion on the floor of GE Aviation?

Priestley: We always saw GE as our main competitor, despite the fact that they're a much bigger company. But in aviation, it's a two-horse race.

O'Reilly: Duopoly.

Priestley: And I think the perception was they had a lot better manufacturing processes, that they probably had less bureaucracy, although I think that's a bad perception. I think every company has a huge amount of bureaucracy, particularly in an industry so heavily regulated as that.

O'Reilly: Right. Because they fly planes with people in them.

Priestley: Yes. But, the perception definitely was, they were a little bit ahead of the curve in terms of the power by the hour industrial internet applications, a little bit ahead of the curve in the manufacturing process. What Rolls-Royce really holds there is the innovation and the engineering quality. But whether or not that's true, I think it's basically peanuts at this point. If anybody is looking at GE's stock now and thinking, it's down 35%, would it be a buying opportunity for you?

O'Reilly: Turnaround story. Gosh, it just sunk below 20. I'm looking at it right now. $19.91 as of 11:25 a.m. on November 2nd. Yowza. Dividend yield 4.8%, is that real? [laughs] 

Priestley: Beware of the dividend yield.

O'Reilly: Right. I might need to look at this as a Ben Graham below book value thing soon. That's what makes a market, you have a bull and a bear. So far today, 31 million shares have traded hands. Somebody sold that, and somebody bought all that. Actually, it was probably an algorithm that doesn't care. It's an unknown quantity, but if you're buying the innovation ramp up and the industrial internet stuff, it would be a fantastic bargain. What I'm nervous about and the reason I'm not jumping into the stock just yet for me or my son's education account or anything like that yet is, my read on Flannery and the choice of him was ... they had faster-growing divisions. The time he was at GE Healthcare, 2014 to 2016, they had faster growing divisions in both revenue and profits, why did they pick him? Literally the first thing out of everybody's mouth was the profit margin, operating margin 100 basis-point expansion. He was the finance guy. He actually helped start GE Finance in the 80s. And to me, I would have wanted what Ford has done. They got a hip tech guy from Steelcase. I think they need to go all in on crazy innovation. What I saw was, they picked somebody like me, a finance guy. Awesome with spreadsheets but Eddie Lampert, CEO of Sears, he's a finance guy, and you hear these stories about how he would just sit with dual monitors in his office running a Sears with massive Excel spreadsheets. And to me, it seemed to me like you needed to get some fashion people and have them go nuts with inventory.

Priestley: I think you and I have differing views on the stock right now.

O'Reilly: You probably have the correct one. [laughs] 

Priestley: I mean, I could have egg on my face as soon as the 13th of November. But, I actually have invested. I think it's priced well.

O'Reilly: It was the dividend, wasn't it? [laughs] 

Priestley: It really got me, that 4.8%. And the reason I think this is, Buffett be fearful when others are greedy and greedy when others are fearful. I think this is a prime example of this. And I think if people wait to see how things shake out it may be too late. This company has been around for 125 years. It's a long time. I think management is trimming the fat and appropriately diversifying. I think the crux of the issue for the company is a PR one. GE has historically been a power, oil and gas company, and those businesses are undoubtedly underperforming. And when those three segments fail, GE doesn't work properly in people's minds, and that has led to some panic. So, understandably so, to a degree, these segments contribute about 50% of the revenue. But to put it into perspective, revenue declined 1%, operating profit 7%, and earnings were off by 9%. So, that's bad for GE. You then have these other segments, as you touched on, Aviation and Healthcare posting profit gains, and organic revenue rising 2% for the first nine months of this year. So, I think the situation you have is, it's getting a bad rap because everybody is so focused on these businesses. But, to touch on what you said, if they can invest in innovation, the industrial internet, if they can add services to their installed base, which is huge --

O'Reilly: Which would be awesome.

Priestley: -- if they can monetize that, it would deliver growth. The margins are 30% in that business.

O'Reilly: Oh my gosh. I didn't know that. That's like a SAAS business, software-as-a-service. You're getting money for taking care of this thing that you sold them. It's awesome.

Priestley: Exactly. And if anyone is listening and they're wondering what we're talking about with this internet of things, industrial internet, for each industrial device GE sells, they can add a little sensor that makes the equipment smart.

O'Reilly: Can they put one of those in me?

Priestley: [laughs] I wish they would do it to me, too. It can record a lot of data. It sends it back to GE, it's analyzed, and then GE basically enacts improvement suggestions so it can become more efficient, it can last longer. Basically, the intention is to reduce the overall cost of that product. As we said, their core industrial operation is cyclical, it tracks the economy, and that's why you're seeing the difficulty that they're having right now in Power with the oversupply in the market, and would be depression in stock prices in oil and gas.

O'Reilly: I almost wonder, we just got a good GDP report, annualized basis was like 3%. I wonder if that's good for them.

Priestley: It should be. We're starting to see a pickup in oil and gas now. So, hopefully they'll benefit from that. But, if basically your whole business, which, 50% of their business is tied to economic growth, which is a few percentage points here and there, what could really unlock the huge amount of potential is increasing these service contracts. As we said, it's 30% potential additional margin.

O'Reilly: For sure.

Priestley: Awesome having you today. Thank you so much!

O'Reilly: This was a wonderful conversation! I've missed it. I'm just going to stand outside the studio.

Priestley: I think you should come back. I think we should talk about it and see if I'm completely wrong on --

O'Reilly: OK, I'll be back in two weeks. That'll be good. [laughs] 

Priestley: I think a lot of the worry about the dividend is priced in right now.

O'Reilly: Yeah.

Priestley: That's my theory. But there could be a mass exodus. Anyway, thank you very much, Sean, for coming in and sharing your wisdom.

O'Reilly: Cannot thank you enough for the invite.

Priestley: That's it from us today. If you would like to get in touch, please feel free to email us at industryfocus@fool.com or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Sean, I'm Sarah Priestley. Thanks for listening and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Sarah Priestley owns shares of General Electric. Sean O'Reilly has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and Ford. The Motley Fool has a disclosure policy.