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What You Must Know Before Buying General Electric Stock

By Lee Samaha - May 1, 2018 at 7:03AM

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Learn how the industrial giant reduced its guidance for power segment profit by $500 million -- and why it will be under pressure to meet its earnings guidance.

General Electric Company (GE 4.70%) first-quarter earnings came in ahead of expectations, and there were plenty of positives to be gleaned from the report -- not least the reiteration of the full-year guidance range. Given the dramatic fall in the stock price -- down 50% in the last year at the time I write this -- the idea of buying in certainly looks enticing. However, before hitting the "buy" button, there's something you need to know about GE's earnings prospects in 2018, and it's not good.

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Image source: Getty Images.

GE will struggle to meet its earnings guidance

The company's full-year adjusted EPS guidance range remains at $1 to $1.07, and adjusted industrial free cash flow (FCF) guidance is still at $6 billion to $7 billion. On a headline basis, that's good news, but the reality is that GE has a lot to do in order to merely meet the bottom end of its guidance range. 

Moreover, new CFO Jamie Miller deserves criticism for the confusing way that segment earnings guidance has been presented. For example, on the earnings call, she talked about the power segment being "about flat to 2017" and declared that performance would be "lower than we outlined at our November investor meeting."

Although technically true, it's not giving the full picture as to just how much GE reduced its previously given power segment guidance. According to JP Morgan analyst Steve Tusa in a CNBC interview,  the implied reduction in guidance from power is actually around $500 million, or $0.05 in EPS. It's a significant reduction, and even though CEO John Flannery acknowledged that full-year EPS is likely to be "to the lower end of the range," GE still has a lot to do in 2018.

How "flat" became a reduction of $500 million

The answer to this question comes from a close examination of how GE gave full-year 2018 segment guidance in its investor update in November. Based on management's guidance on the investor update and reported 2016 figures my calculation for what GE was guiding toward for 2018 in its key segments is in the table below.

Segment

2018 Estimate at November Investor Update (in billions)

Aviation

$6-$6.25

Power

$2.45

Healthcare

$3.64-$3.7

Data source: Company presentations. Author's analysis and calculations.s. 

Fast forward to the guidance and commentary given on the first-quarter earnings call and Miller's reference to "flat" power performance in 2018 compared to 2017. The key point to understand here is that the guidance on the earnings call was based on restated results for 2017, and here GE's power segment profit was just $1.95 billion. In other words, Miller's guidance actually implies a $500 million reduction in guidance for power segment profit i.e. from $2.45 billion to $1.95 billion.

It won't be easy to offset the $500 million reduction

The $500 million will have to made up elsewhere, but it won't be easy. Flannery believes "we expect earnings pressure in Power will be offset by better Aviation and Healthcare earnings and lower corporate costs. Renewables, transportation and oil & gas should be about as expected."

As you can see above the difference between the low and high points of aviation and healthcare guidance is $250 million and $30 million respectively, so even if both segments come in above the high-end of guidance it's hard to see where the $500 million can be made up. There will be pressure on healthcare and particularly aviation, in order merely to hit the low point of management's 2018 guidance. It's also worth noting that management didn't upgrade guidance for the aviation segment when asked by Tusa on the earnings call.

Moreover, management acknowledged that the power market continues to weaken in 2018 and Flannery's outlook on end markets is bleak. End market demand for heavy-duty gas turbines (GE's core product in power) was 48 gigawatts in 2016 and the 34 in 2017, and Flannery thinks "we believe the 2018 market is trending below 30 gigawatts and we think this is the type of market that we are going to be looking at in general for the next few years."

What GE needs to do

All told the power segment remains in decline and management's outlook suggests there could be more pressure to come. Flannery is already guiding investors toward the bottom end of its 2018 EPS guidance range, and any kind of slowdown in aviation will surely see GE cut its full-year guidance -- something to consider before buying GE stock.

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