The troubles that industrial icon General Electric (NYSE:GE) has been dealing with are headline grabbers. The biggest story has been its heavy debt load and the efforts to sell assets to get its balance sheet back into shape. However, that's not the whole story. Even if the company manages to buy itself time in this long and slow-moving turnaround effort, it still has a big problem to tackle in its operating businesses and there's no easy fix. This is what you need to be watching if you are looking at GE today. 

Getting less ugly

The first really big issue for General Electric to deal with, without question, was its balance sheet. This is the financial foundation of a company, and if it isn't strong, even a great business can end up crumbling. So it makes complete sense that CEO Larry Culp, who assumed the helm in late 2018, quickly focused on strengthening the company's financial position. That notably included selling assets, the biggest being a piece of the company's healthcare division, which closed in early 2020, to Culp's former employer Danaher

A compass with the arrow pointing to the word strategy

Image source: Getty Images.

This sale brought in a huge $21.4 billion in cash. That money will give the company material breathing room to deal with its remaining issues. To put some numbers on the improvement that's been made, the company's debt-to-equity ratio has fallen from more than 3.6 in the third quarter of 2018 to 2.4 at the end of the first quarter. A lot of progress has indeed been made under Culp's leadership.

GE Debt to Equity Ratio Chart

GE Debt to Equity Ratio data by YCharts

At this point, the somewhat opaque finance arm, which had roughly $56.6 billion in debt maturities outstanding as of April 23 compared to just $17.3 billion on the industrial side of the business, is the segment that perhaps continues to garner the most attention. That's fair, given that GE's finance business imploded during the 2007-2009 recession and has been a weight on the company's neck ever since. However, there's a longer-term issue brewing that could be even bigger.

How the power and renewable energy segments are doing

GE breaks what remains of its business down into four divisions: aviation, healthcare, power, and renewable energy. Aviation and healthcare accounted for roughly 60% of the company's top line in the first quarter. These businesses have performed well historically, and, generally speaking, continue to do so. For example, segment margins in the first quarter were solid, at 14.6% for aviation and 19% for healthcare, despite the early impact of COVID-19. Yes, margins were weaker than they were in previous quarters, but they held up well under pressure. 

The remaining 40% of revenue is attributable to power and renewable energy. These two divisions have not been performing well. In the first quarter they had segment margins of negative 3.2% and negative 9.5%, respectively. Those are not good numbers, but they aren't dramatically out of line with recent segment results. For example, power had negative free cash flow of $2.3 billion in 2018 and negative $1.5 billion 2019. Renewable energy had positive free cash flow of just $100 million in 2018, and negative free cash flow of $1 billion in 2019. In other words, more cash is going into these businesses than is coming out of them. 

There's no easy fix. The power segment makes the turbines that go into electric power plants. COVID-19 has increased the pressure in the sector, with GE announcing in the first quarter that it was streamlining the division via job cuts, cost cuts, and a reduction in capital spending plans. This isn't the first time it has gone down this route. Even if the company manages to get the division scaled in line with demand, however, it still needs to turn the division from a cash drain to a cash producer. So far, that hasn't been going particularly well.

A part of the problem the power group is facing is the ongoing shift toward renewable power, which should be a net benefit to the company's renewable energy division, which makes things like wind turbines. But the financial results don't show that at all. In fact, things look like they are getting worse, not better. Part of the problem in the first quarter was the impact of COVID-19, of course, but there's real potential for a lingering impact, as renewable power projects may get delayed. It's not comforting to see General Electric continue to struggle in an industry that is becoming an increasingly important portion of the global electric grid.

The rest of the turnaround story

No matter how much progress General Electric makes on its balance sheet, it clearly still needs to get half of its business units, representing 40% of revenue, back on track. And since both power and renewable energy lost money in the first quarter, they continue to drag down the company's overall results. Until there's sustained progress turning these segments around, GE will have a very material problem that needs to be solved. This is the story on which long-term investors should focus when the company reports second-quarter earnings.