How Is Flannery Changing GE?

General Electric (GE 1.30%) has a new head in the CEO chair, and while it's too soon to see any changes reflected in guidance, John Flannery has started pushing through some big culture changes in a very established company.

In this clip from the Industry Focus: Energy podcast, host Sarah Priestley is joined by Fool contributor Sean O'Reilly to talk about why GE has performed so poorly in the past few years, how the company did on this most recent earnings report, some of the biggest and most meaningful changes that Flannery has already started to make for the company, and how GE might change in some major ways.

A full transcript follows the video.

This video was recorded on Nov. 2, 2017.

Sarah Priestley: 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.

Sean 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 Aug. 1. What do you make his performance so far?

O'Reilly: 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.