Shares of industrial giant General Electric (GE 2.39%) have plunged over the past year due to deteriorating performance in the company's power business -- historically its largest segment by revenue -- and investor fears about hidden liabilities in the GE Capital financing business. GE slashed its dividend by 50% last fall, but some analysts have warned that a cash crunch could force it to abandon the dividend entirely.
The reality isn't quite so bleak. Last Friday, General Electric silenced many of its critics with solid first-quarter results. While the company still faces earnings pressure from the power and GE Capital segments, the valuable aviation and healthcare segments are performing very well. Furthermore, GE's turnaround plan appears to be on track.
Aviation continues to support profitability
General Electric reported adjusted earnings per share of $0.16 for the first quarter, comfortably beating the average analyst estimate of $0.11. Based on current accounting standards, EPS was $0.14 in the year-ago period, so GE's Q1 result represented a year-over-year improvement.
That said, under the accounting standards and reporting scheme that General Electric was using last year, GE reported adjusted EPS of $0.21 in the first quarter of 2017. Thus, while GE's performance has improved modestly on an apples-to-apples basis, the company is not as profitable as it seemed to be at this time last year.
GE's power segment is facing steep sales and earnings declines. Image source: General Electric.
Looking at GE's business units, the power and oil and gas segments both posted steep earnings declines of 30% or more. However, aviation segment profit surged 26%, reaching $1.6 billion. Strong services revenue, good cost control, and a favorable product mix all contributed to this impressive result. The healthcare segment also delivered another solid performance, with segment profit up 11% year over year to $735 million.
The aviation and healthcare segments now account for the bulk of GE's earnings. Together, they produced 87% of the company's first-quarter segment profit. The aviation business in particular is benefiting from strong secular tailwinds. Orders increased 13% year over year in the aviation segment last quarter, outpacing revenue by about $1 billion.
Free cash flow continues to improve
Free cash flow is another key metric that investors are watching at General Electric. Indeed, as GE's recent special charges and accounting changes have led to questions about its true earnings power, free cash flow has assumed greater importance in terms of evaluating the company.
Industrial free cash flow was negative last quarter to the tune of $1.7 billion. However, this was driven by inventory buildup related to the typical seasonality of GE's business. Free cash flow actually improved on a year-over-year basis by about $1 billion.
For the full year, General Electric still expects to produce $6 billion-$7 billion of free cash flow, up from about $5.3 billion last year. This reflects the company's increasing focus on maximizing cash flow rather than revenue or accounting earnings.
Restructuring is on track
A final good sign for General Electric shareholders is that the company is making progress on its various restructuring initiatives. First, GE is rapidly cutting structural costs as it works to right-size its overhead to line up with its slimmed-down ambitions. The company reduced structural costs by $805 million last quarter, putting it on pace to exceed its $2 billion full-year cost savings target.
Second, while GE didn't close any major asset sales last quarter, it is on track to complete several key deals during 2018. For example, the sale of its industrial solutions unit to ABB is set to close in the second quarter. The net proceeds to GE after taxes will be $1.9 billion. Furthermore, GE recently agreed to sell a healthcare IT business for $1.05 billion. That deal is set to close in the third quarter.
Looking further ahead, GE also expects to sell its entire current and lighting division by year-end. Finally, it is making progress on divesting its transportation segment. It is talking to Wabtec about a potential sale of its rail business, which represents the biggest piece of this division. It is also considering spinning off the whole segment through an IPO.
These deals will give GE some breathing room as it works to balance dividend payments with the need to reduce its debt and pension liabilities. Furthermore, they will simplify GE, making it easier for management to pilot a turnaround for the rest of the company.
