Last year was an exciting one for General Electric (GE -0.24%) shareholders, with the stock putting on a 45% gain -- a performance that made it one of the best-performing industrial stocks of the year. However, one of the key reasons why GE outperformed in 2019 -- handily beating its own guidance -- is going to be prove hard to repeat in 2020. Here's why.
Underpromising and overdelivering
Back on its 2019 outlook day in March 2019, GE management forecasted industrial free cash flow (FCF) in the range of an outflow of $2 billion to zero. It was a startlingly weak outlook at the time, but it ultimately proved too conservative, with full-year 2019 FCF coming in at $2.3 billion.
While it's easy to suggest that CEO Larry Culp was deliberately low-balling guidance in order to beat it, the reality is that GE needed to get back to the days of underpromising and overdelivering -- not least because the two former CEOs, Jeff Immelt and John Flannery, both did the opposite. GE had a guidance credibility issue, and Culp has helped solve it.
Source: Getty Images
The 2020 version
Fast forward to 2020, and the market awarded GE stock a double-digit increase after a fourth-quarter earnings report which contained FCF guidance of $2 billion to $4 billion for 2020. That's an impressive figure -- not least because GE will lose a significantly cash-generative business in 2020 when it sells GE biopharma ($1.3 billion worth of FCF) to healthcare stock Danaher, and the FCF from dividends from Baker Hughes ($350 million in 2019) as its stake is sold down. Both these events are baked into GE's FCF guidance for 2020.
Moreover, with the Boeing 737 MAX only expected to return to service at the mid-year point -- GE's joint venture with Safran, CFM International, makes the LEAP engine used on the MAX -- GE's FCF guidance for 2020 also has the negative effect of the lack of a full year's production on the MAX.
Putting all this together, GE investors had three reasons to feel optimistic about FCF in 2020 and beyond:
- GE's implied FCF guidance is probably significantly understating what its underlying run rate of FCF generation could be if the MAX was in full production.
- The improvement in expected FCF -- considering GE biopharma and Baker Hughes drop out in 2020 -- is actually quite significant.
- After underpromising and overdelivering in 2019 -- significantly surpassing its own FCF guidance -- investors had cause to believe GE could do the same in 2020.
Enter COVID-19
Unfortunately, there's reason to believe that this bullish prediction is being challenged by events. While most commentators still expect a return to service for the MAX in due course -- something that will boost GE through increased LEAP production and ultimately lucrative aftermarket revenue for years to come -- the COVID-19 outbreak is challenging the notion that GE can sail past its own guidance again in 2020.
For example, at the recent investor outlook meeting, Culp said that the COVID-19 outbreak would lead to a negative effect on FCF of some $300 million to $500 million in the first quarter alone, with $200 million to $300 million of the effect seen at GE Aviation.
However, he maintained the full-year FCF target of $2 billion to $4 billion. This would appear to be good news, but here's the thing. GE's full-year FCF guidance doesn't include any effects for COVID-19 beyond the first quarter, and a raft of data continues to suggest that the overall situation is getting worse.
As you can see below, the growth in new confirmed new cases has shifted from countries in the Far East toward Europe. In other words, it has internationalized. This means any modeling of its effects on the economy and company earnings must now be considered on a global basis, and not just in the Far East -- not great news for GE Aviation.
Data source: World Health Organization. Chart by author.
What it all means to GE investors
In a nutshell, GE probably didn't reduce its full-year FCF guidance, even as it outlined a $300 million to $500 million effect in the first quarter, because the original guidance of $2 billion to $4 billion was wide enough to encompass it. It's possible that Culp was being as conservative with guidance as he was in 2019.
However, it looks likely that the COVID-19 effects will extend beyond the first quarter, and there will be pressure on earnings and FCF guidance in 2020. All of this means that if you think that GE is going to repeat its trick of underpromising and overdelivering in 2020, you might need to think again.
