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5 Key Conclusions From General Electric Company's Investor Update

By Lee Samaha - Nov 14, 2017 at 3:04PM

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The cash flow outlook is arguably getting worse, while new plans place more pressure on GE Power to perform.

On Monday, General Electric Company (GE 1.30%) CEO John Flannery finally updated investors on his strategic plan for the company, and by now, most investors will know that it involves cutting the annual dividend yield in half to $0.48. The dividend cut is painful, but if it helps get the company back on track and the stock price appreciates accordingly, most investors would be happy. Indeed, Flannery took center stage during the update conference call in order to convince shareholders that he is the man for the job. However, in analyzing the presentation, it becomes clear that the person responsible for executing the plan is probably going to be someone else. Let's take a look at the key takeaways from the update and find out who that person is.

a GE gas turbine against a blue background

General Electric Company's investment prospects depend on its power segment. Image source: General Electric Company.

1. Earnings guidance

Ever since the disastrous set of third-quarter earnings, investors were looking forward to the GE investor update in order to see where earnings and, in particular, cash flow would go in 2018. GE's cash flow projections for 2017 implied it wouldn't be able to cover the dividend distribution from its cash flow generation alone, but what would 2018 bring?

Starting with earnings, adjusted industrial earnings per share (excluding pension cost and GE Capital items) in 2017 are still forecast to be in the range of $1.05 to $1.10, but adjusted EPS in 2018 is forecast to be in the range of $1 to $1.07, implying a decline at the midpoint.

2. Cash flow guidance

However, the really interesting news comes from the cash flow guidance. (This gets a bit complicated, so take a deep breath and I'll explain.) GE reports industrial cash flow from operating activities (CFOA) because it's a good way to measure ongoing performance. For reference, the industrial CFOA is GE's CFOA excluding the GE Capital dividend -- useful to know because GE has been selling off its Capital businesses in a bid to focus on its industrial core.

However, it doesn't stop at industrial CFOA, because GE still needs to make capital expenditures on plant, property, and equipment (PP&E) and also to fund pensions and pay deal taxes. PP&E is part and parcel of running a company and is always accounted for when calculating free cash flow (FCF), but pension funding and deal taxes are not recurring.

Management wants investors to focus on industrial CFOA and industrial FCF on an ongoing basis, so I've put them in bold in the guidance table below. As you can see, there's an expected year-over-year improvement for both bolded metrics, and the forecast $6 billion to $7 billion in industrial FCF should cover the dividend payout of $4.2 billion (or $0.48 per share) in 2018. That's the good news. 

However, note that after pension funding is paid for, GE's cash available for dividends from operating activities is actually going to be less than it will be in 2017. Furthermore, Flannery said that GE is borrowing money to fund the pension. However, you could look at it another way: GE is borrowing money to support the dividend.  

 Metric

2017 Estimate (in billions)

2018 Estimate (in billions)

GE CFOA ex deal taxes and pension

$11*

$9-$10*

GE Capital dividend

$4

$0

Industrial CFOA ex deal taxes and pension

$7

$9-$10

PP&E

$4.1

$3

Industrial FCF ex deal taxes and pension

$3

$6-$7

Pension and deal taxes

$2

$6

Cash flow after pension funding

~$1*

$0-$1*

Data source: General Electric Company presentations. *Based on author's assumptions. Calculations by author. 

3. Disposals to come

Flannery had already announced that he was planning to exit $20 billion worth of assets, but in the presentation, he named them. They include the deal to sell the GE Industrial Solutions business to ABB -- a business whose margins suggested that GE had not been running it well -- as well as exploring the sales of its transportation and current and lighting assets. Meanwhile, selling the stake in Baker Hughes, a GE company is also being explored.

While the potential exits, sales, or spinoffs would release value, remove significant oil and gas exposure, and focus GE on its industrial core, it's worth noting that selling these businesses would further reduce CFOA. Moreover, transportation and lighting are businesses with a high level of cash generation. In fact, they convert more than 100% of net income into FCF, an impressive figure, particularly when compared with GE's forecast of just 60% FCF conversion for the power segment in 2018.

4. Strategic change

Flannery's willingness to explore options with Baker Hughes and his recognition of the problems in the power segment -- not least the disappointment with the Alstom energy assets acquisition -- make it clear why former CEO Jeff Immelt left the company.

Immelt was the key decision maker in GE's bet on oil and gas as the company made a series of acquisitions during a period when oil prices were much higher. Similarly, the Alstom deal was made before it became clear that the power market would deteriorate. Clearly, Flannery has been brought in to execute better, particularly with the ailing GE Power segment, and he highlighted his track record of running GE Healthcare as evidence of his ability to do so.

5. GE Power's Russell Stokes is the man to watch

The new president and CEO of GE Power may well be the person on whom investors need to pin their hopes. If GE is going to exit $20 billion worth of business and possibly sell its Baker Hughes asset, then power technology is probably going to become an even larger part of the company's business.

In addition, it's the most troubled segment of GE's operations, and one from which investors will want to see margin and cash flow improvement -- not least because disposals elsewhere could pressure overall CFOA generation in the future. 

All told, the investor update highlighted GE's ongoing and future dependence on its power segment. Now Stokes and Flannery need to get it back on track. 

Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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