GE Renewable Energy doesn't get a lot of attention during investor conferences. But if you're looking to build a bullish case for buying General Electric (NYSE:GE), you must include positive assumptions about this segment. It could swing the needle in terms of earnings and cash flow over the long term. Here's why it's GE's most interesting business.

Why GE Renewable Energy matters

It might seem bizarre to single out the renewable energy business. After all, it's currently loss-making and eats up cash. However, it is the GE division with the biggest potential to surprise investors. 

Looking at the other segments, the healthcare business is low-growth now that the biopharma segment has been sold. In fact, GE Healthcare only generated $1.2 billion in free cash flow (FCF) in 2019. Aviation will obviously be the biggest earnings/FCF generator in the future, but investors already knew that.

Since the power segment is being restructured, investors can expect more margin improvement to come with positive FCF in the 2021-2022 time frame. However, there are questions around the long-term demand for gas turbines in light of the growth in demand for renewable energy for electricity generation. Even GE CEO Larry Culp spoke of an "energy transition."

A wind turbine.

Image source: Getty Images.

All of which leaves GE's renewable energy segment as the business with the greatest potential to turn around FCF generation and grow over the long term. You can see in the table below how the company's various segments performed last year.

Segment, Full Year 2019

Revenue

Segment Profit

Segment Margin

Free Cash Flow

Power

$18.6 billion

$0.4 billion

2.1%

($1.5 billion)

Aviation

$32.9 billion

$6.8 billion

20.7%

$4.4 billion

Healthcare

$19.9 billion

$3.9 billion

19.5%

$2.5 billion

Renewable Energy

$15.4 billion

($0.7 billion)

(4.3%)

($1 billion)

Data source: General Electric.

GE Renewable Energy

To get an idea of what to expect for the renewable energy division, look at the guidance for the segment given in the investor presentation on March 4. It has been replicated in the table below. As you can see, FCF won't be positive until at least 2022, and the segment's margin won't break even until 2021. As noted in the presentation, this is a long-term story.

Business Within GE Renewable Energy

2019 Actual

 2020 Guidance

 2021 Guidance

Core onshore + LM Wind Power revenue

$10 billion

up

flattening

Offshore revenue

$0 

up

up

Grid and hydro revenue

$5 billion

down

flattening

Total revenue

$15 billion

low single-digit growth

up

Segment margin

(4.3%)

Improving, but negative

breakeven

Free cash flow

($1 billion)

lower

better, but still negative

Data source: General Electric.

That said, Culp believes GE Renewable Energy can reach the high single-digit profit margins achieved by peers Vestas and Siemens Gamesa. Indeed, going into 2020, Vestas expected an adjusted earnings before interest and taxation (EBIT) margin of 7% to 9% for 2020, and Siemens Gamesa was expecting 5.5% to 7%. So, the potential for GE is obviously there.

In this context, it's possible to conceive of a combination of low single-digit revenue growth (from $15 billion in 2019) and high single-digit margin leading to $1 billion in earnings and FCF in the next five years for GE Renewable Energy. That would result in a $2 billion swing in FCF from 2019.

How GE Renewable Energy can generate value

The three different parts of the segment have unique pathways to success. For onshore wind and LM Wind Power, Culp sees success largely in terms of internal execution efforts, such as cost-cutting, better procurement, and enhanced business support -- implying that margin improvement largely comes down to self-help initiatives.

The disastrous acquisition of Alstom's energy businesses gave GE its grid and hydro holdings. Culp sees them as turnaround situations. New management is in place to cut costs and only take on profitable work. The revenue growth outlook isn't great, but margin should improve.

GE Renewable Energy's Haliade-X offshore wind turbine.

GE Renewable Energy's Haliade-X offshore wind turbine. Image source: GE Reports.

The wild card is GE's bet on entering the offshore wind power market with its monster wind turbine, the Haliade-X. Speaking at a recent investment conference, Culp said there was "lots of customer interest... That's going to take several years for those as indications of interest to become profitable revenues, but that's a bet GE can and should be making."

It's possible that, in a few years, GE Renewable Energy could look like a company on an improving margin trend, with $1 billion in FCF in view. Moreover, onshore wind is a growth market. There's potential for some upside surprise from offshore wind if orders for the Haliade-X kick in.

What it all means for investors

The aviation segment is the key to GE's future, and its fortunes will play out in line with the shape of the recovery in commercial aviation. Healthcare and power don't look like high-growth business over the long term. GE will need the renewable energy business to start performing in order to convince investors of the long-term value in the stock.

All told, if you are looking for some upside surprise to GE's long-term prospects, then you should focus on two things in 2020. First, margin improvement in the renewable energy segment -- something largely in management's hands. Second, the development of orders on the Haliade-X.  It will be years before these things start to show up in the bottom line, but over time GE Renewable Energy could turn into a growth business for GE.