On Thursday morning, General Electric (GE 1.21%) reported that adjusted earnings per share plunged to $0.17 last quarter from $0.43 a year earlier. This EPS result missed the analyst consensus of $0.22 by a wide margin.
At first glance, GE's quarterly performance would seem like an unlikely catalyst for a big stock price rally. However, that's just what happened: GE stock surged roughly 12% on Thursday, breaking back above the $10 mark for the first time in three months.
Investors were willing to look past General Electric's subpar Q4 results because there were no devastating surprises in its earnings report. (In fact, the company eliminated one major risk that had previously unnerved investors.) Furthermore, GE's lucrative aviation business continued its torrid growth last quarter, supporting GE stock's rebound.
Getting realistic at GE Power
GE stock tumbled 76% between the beginning of 2017 and the end of 2018, knocking more than $200 billion off the company's market cap. The main driver of this plunge was a string of dreadful results at General Electric's power business.
In 2016, GE booked a $5 billion profit in its power segment. But by late 2017, the company was projecting that operating profit would fall to around $4 billion in 2017 and $3 billion in 2018. At that time, management expected the power business to burn cash in 2017 but achieve a 60% free cash flow conversion rate in 2018, implying about $1.8 billion of free cash flow.
Unfortunately, General Electric has fallen far short of those targets, due to a combination of poor planning, weak market conditions, and execution mistakes. The power segment posted an ugly full-year loss of $808 million in 2018 and burned $2.7 billion of cash. Management indicated that 2019 will be another bad year for the power business.
Check out the latest GE earnings call transcript.
That said, CEO Larry Culp expects the power segment's profitability to improve steadily after 2019. Moreover, he emphasized that this forecast doesn't assume that market conditions will improve, saying: "Embracing market reality means a more appropriate revenue outlook, one that is further grounded in the reality of our $92 billion backlog rather than in the hope of new orders not yet won."
This wasn't exactly a bullish outlook, but investors were relieved to see that Culp is addressing the power business's problems head-on, rather than counting on a miraculous jump in demand.
One big risk goes away
General Electric also ended speculation about how much it might have to pay to settle mortgage fraud allegations against its former subsidiary WMC Mortgage. GE booked a $1.5 billion charge last year for a potential legal settlement with the U.S. Department of Justice related to this issue. However, some analysts warned at the time that the DOJ might demand a bigger settlement.
On Thursday, GE revealed that it had reached a tentative agreement to pay $1.5 billion to settle the DOJ's investigation. Having certainty on this subject is good news for GE stock, particularly because many investors have been worried about potential hidden liabilities at GE Capital.
GE Aviation keeps soaring
One part of General Electric's business continued to post excellent results in 2018: GE Aviation. Segment profit soared 24% to $1.7 billion last quarter on $8.5 billion of revenue (up 21% year over year).
For the full year, aviation segment revenue rose 13% to $30.6 billion, making it GE's largest business segment. General Electric saw growth in both equipment sales and service revenue, driven by strong demand for new planes and high aircraft utilization. Segment profit grew at an even faster 20% clip, reaching $6.5 billion -- more than all of GE's other segments combined.
This level of growth isn't sustainable. For 2019, GE expects a more modest high-single-digit revenue increase and low-single-digit profit growth in the aviation segment. That said, aviation segment orders reached $35.5 billion last year -- well ahead of revenue -- and the segment backlog reached $223.5 billion. Thus, GE's largest and most lucrative business still has a lot of room for future revenue and earnings growth. That's great news for GE stock.
Growth in aviation and stability elsewhere
GE Aviation's annual earnings could easily double over the next decade as the recent boom in aircraft production translates to a rising tide of service revenue in the coming years. That's why GE Aviation is likely worth more than $100 billion -- more than GE's entire market cap.
GE stock doesn't reflect the full value of the aviation business for two reasons. First, many investors are skeptical about GE Aviation's long-term growth trajectory. The company's fourth-quarter results and 2019 outlook helped to refute some of these concerns.
Second, investors have been worried that GE Power's losses could continue indefinitely and new liabilities could turn up at GE Capital. As a result, investors are likely to reward any evidence of stabilization in these problematic businesses. If GE Aviation continues its growth and GE can avoid any additional negative surprises at GE Power and GE Capital in 2019, GE stock could keep flying higher this year.