It's not often that analysts and investors walk away from an industrial conference thinking of General Electric's (NYSE:GE) outlook as one of the highlights, but that's exactly what attendees were probably thinking after hearing CEO Larry Culp's presentation at the Morgan Stanley Laguna conference. Culp had some long-awaited good news regarding GE's beleaguered power segment. Let's take a look at what he said and what it means to investors.
Culp gives a brighter outlook on power
It wasn't accompanied by a lot of fanfare, and Culp delivered the news in his usual calm manner, but if you listened carefully you would have heard him say that it "appears we may see a market somewhat north of 25 to 30 gigawatts" for the year and "perhaps a little bit" of a tailwind going into the next couple of years.
He was talking about industrywide large gas turbine orders in terms of power. As you can see below, the market has halved in the last five years, and GE's current outlook and planning assumption is for 25 gigawatts to 30 gigawatts. In a nutshell, Culp just upgraded the outlook and suggested some improvement going forward. That's good news for an industry that's been struggling to cut capacity quickly enough in order to maintain profit margin.
Why it matters so much
In a sense, this news is due. After all, low gas prices have helped to encourage the use of natural gas as a source of electricity production -- something that underpins demand for gas turbines. In addition, while renewables have undoubtedly gained ground -- making renewables stocks interesting to invest in -- gas is still a cost-effective and viable option around the world.
It's hard to overstate how big the issue of the gas turbine end market has been in recent years. Indeed, the two former CEOs of GE both fell on their swords while clinging to untenable earnings guidance built on overly optimistic assumptions on the power division's profitability.
Exceeding expectations in power
In a sense, Culp's first task as CEO of GE was to reset power expectations and earnings and cash flow guidance to more realistic levels and then set about exceeding expectations. This may seem an easy enough task -- especially when the bar is set low to begin with -- but consider that neither Jeff Immelt nor John Flannery managed to do it.
Moreover, it's worth noting that GE actually raised its guidance range for full-year free cash flow (FCF) generation during the second-quarter earnings call. Instead of a range of adjusted industrial FCF of negative $2 billion to $0, GE now expects negative $1 billion to $1 billion -- that's an improvement of $1 billion at the midpoint of the range. Half of the improvement in the outlook came from lower restructuring expenses, and the bulk of the other half came from the power segment -- a good sign.
GE investors can also take heart from the fact that its big rival in power, Germany's Siemens (OTC:SIEGY), is also taking significant restructuring actions in order to reduce capacity. When the key players in a sector (the only other major player is Mitsubishi) are reducing capacity, it's usually the first step toward halting the pricing erosion that usually takes place in an industry suffering from overcapacity.
In reality, it's very difficult to predict gas turbine demand, so while GE and Siemens can both get unfavorably caught out by a move to the downside -- as has happened in the last five years -- they can also be positively surprised by a move to the upside. Culp's commentary, albeit tentative, suggests the heavy-duty gas turbine market might just be about to trough in 2019.
Headwinds still remain for GE
That said, GE still has faced some significant headwinds in 2019. There are still question marks around its long-term care obligations, and the ongoing grounding of the Boeing 737 MAX could hurt GE's FCF, at least in the near term. As a reminder, GE's joint venture with Safran, CFM International, manufactures the LEAP engine for the 737 MAX and also the Airbus A320 NEO.
If the 737 MAX gets back into service and Boeing starts delivering them again, GE will get the cash for the engines, but investors will, naturally, have concerns until that happens.
The bottom line
In an industrial environment in which companies are having to take down guidance as a result of falling end demand, it's good to see GE's outlook moving in the other direction. There are still potential headwinds and question marks around the company, but positive underlying conditions in aviation and an improving outlook in power mean GE is one of the few industrials exceeding expectations in 2019. That's a step in the right direction.