It took less than 20 years for GE (GE -0.76%) to go from having the world's largest market cap to fighting for its life. Larry Culp, who took over as CEO in 2018, has made an effort to resolve these issues. A rising stock price over the last few months shows that he is gradually winning the confidence of investors.
However, massive debt levels and continuing losses led to fears that the company would not survive. Moreover, the financial press has discussed extensively issues such as cash flow and troubled divisions like GE Power. Still, with these three unexpected challenges, investors need to take a cautious approach with GE stock.
Amid troubles for the conglomerate, many had seen GE Aviation as one of the bright spots in the company. In the previous quarter, revenues at the division increased by 8% and made up nearly $8.8 billion of GE's $22.5 billion in reported revenue. Aviation also accounted for almost $1.72 billion in profit as the company reported a quarterly loss in GAAP earnings.
However, in previous earnings reports, Mr. Culp did not rule out unexpected challenges appearing. This is precisely what happened when Boeing grounded its 737 MAX, a plane for which GE supplies engines. This led to a 27% reduction in overall orders at Aviation. As of the third quarter, GE saw a $1 billion impact from the 737 MAX. Now, with production suspended, the outlook only becomes more uncertain.
Despite the setback, the Aviation division managed to increase its backlog 20% year-over-year in the previous quarter, due primarily to service agreements. It also helps that Mr. Culp addressed this issue quickly. Still, as a company working to clean up its balance sheet, the 737 MAX delays deprive GE of a needed revenue source.
GE Capital once accounted for about half of the company's profits. However, that division became a focal point of the financial crisis as the company held billions in toxic assets. The company continues to resolve these concerns. Last year, it put its subprime mortgage business, WMC Mortgage, into bankruptcy. Earlier in 2019, GE paid a $1.5 billion fine for misrepresenting the quality of the loans made at WMC before the financial crisis.
This did not completely dispel concerns about toxic assets. Charges by Harry Markopolos reminded investors of this fear last summer. In August, he alleged that GE was hiding a fraud "bigger than Enron and Worldcom combined." That sent shares tumbling by more than 11% in a single day. Larry Culp responded immediately, calling the charge "market manipulation" and personally buying $2 million worth of shares.
Mr. Culp appears to have prevailed for now. The "gefraud.com" website has been taken down. Moreover, since Larry Culp bought those shares, GE stock has risen by almost 50%. However, what happened with Enron and Worldcom shows that fraud can happen at any company. The existence of subprime assets only heightens this fear with GE.
Despite almost 11 years of expansion, no signs of a recession have appeared. However, since the end of World War II, economic expansions have lasted for an average of 58.4 months. The current economic growth period, which began in March 2009, has now persisted for 130 months. This does not mean a recession will occur soon. However, downturns happen eventually, and the length of this expansion cycle increases the risks.
For all of the recent optimism surrounding GE, its recovery remains fragile. Cash flows have only begun to turn positive. Moreover, most of the debt payoffs have come from selling divisions. Even with asset sales and debt payoffs, this $102 billion company still holds more than $96 billion in debt. A slowing economy could easily send cash flows back in the red as both revenue and earnings fall. A falling stock price could start a vicious cycle that takes the debt to equity ratio to untenable levels.
Where GE Stands
The recovery path for GE stock remains tenuous. The constant drip of negative news stopped soon after Larry Culp became CEO. Mr. Culp has also quickly addressed new issues such as slowing aircraft engine sales. Moreover, a rising stock price, as well as cash flows turning positive, have helped to boost the stock price back to almost the $12 per share level.
Nonetheless, several factors that receive relatively little attention could slow or possibly end the recovery for GE stock. Though GE Aviation remains solid as a division, the setback with the 737 MAX means at least a temporary loss of a lucrative, steady source of business. Moreover, despite the discrediting of the Markopolos report, the massive drop in GE stock shows that fraud concerns have not entirely abated. Finally, the length of the economic expansion increases the danger of a recession at a time when the company struggles to sustain any setbacks.
GE's improving balance sheet bodes well for shareholders. However, given the ongoing concerns with the company's financial position, General Electric bulls should continue to treat GE stock as speculative.