Last Wednesday, General Electric (GE 1.49%) held its annual investor-outlook meeting. Two big news items overshadowed the regular agenda: a deal to sell the GECAS aircraft leasing business to top rival AerCap Holdings and a planned reverse stock split.
Yet while these news items captured the big headlines, they weren't the most important takeaways from the investor event. Here are the most consequential pieces of information that GE's management shared.
Power and renewables are on the road back to health
Not too long ago, GE's power and renewable energy businesses represented huge drags on its cash flow. In 2019, the two segments together generated nearly $34 billion of revenue but posted negative free cash flow to the tune of $2.5 billion.
In 2020, combined revenue for the power and renewables segments slipped to $33.3 billion. Nevertheless, a variety of efficiency initiatives helped the company to achieve breakeven free cash flow at GE Power while reducing cash burn at the renewables business to $641 million.
A GE Power turbine. Image source: General Electric.
At the investor meeting, management projected that the power and renewables segments' turnarounds will gain momentum over the next few years. For 2021, GE expects both businesses to expand their profit margins. And while GE Power is on track to report another year of roughly breakeven free cash flow, the renewables business should return to positive free cash flow this year.
Looking further ahead, management expects margin expansion and free cash flow growth for the power and renewables segments in 2022. Additional improvement is likely in 2023 and 2024, as GE finishes restructuring those two segments and the company's promising offshore wind business gains scale.
The net result is that the power and renewables businesses are primed to become meaningful contributors to profitability and cash flow again within two to three years. That would represent a huge turnaround compared to 2019.
GE Aviation will get back to form
Before the pandemic, GE's aviation business was the industrial conglomerate's biggest cash cow. In 2019, GE Aviation generated $4.4 billion of free cash flow on $32.9 billion of revenue. But the sharp drop in air travel over the past year caused the aviation segment's revenue to fall to $22 billion in 2020, while free cash flow plummeted to around breakeven.
Management doesn't expect much revenue growth in 2021. Aircraft manufacturers have slashed output, while airlines have reduced their schedules and are managing utilization to limit the number of expensive engine overhauls needed in the near term. Nevertheless, GE Aviation's profit margin is poised to rebound to double-digit territory this year, thanks to cost cuts and lower restructuring expenses.
A GE jet engine in a test bed. Image source: General Electric.
Fortunately, engine maintenance activity should return to 2019 levels by 2023. That would enable free cash flow to recover to more than $4 billion (roughly in line with the segment's 2019 performance). Even better, GE Aviation's management expects further increases in revenue, earnings, and free cash flow after 2023, driven by growth in its military business and higher maintenance activity for engines delivered during the recent aviation boom.
Perhaps this outlook seems wildly optimistic to some investors. But despite the pandemic, GE Aviation ended 2020 with a $260 billion backlog, mostly covering high-margin services. The global airline industry will return to its long-term growth trajectory within a few years, enabling GE to capitalize on this backlog. That will power a huge surge in GE Aviation's revenue and cash flow relative to 2020.
GE can meet and even exceed its targets
General Electric's stated medium-term goal is to achieve a high-single-digit free cash flow margin. Assuming that revenue recovers to around $90 billion, that would imply annual free cash flow of perhaps $7 billion to $8 billion. With GE's market cap currently standing around $108 billion, there's plenty of upside for GE stock if it can grow free cash flow to this level by 2023.
But based on management's latest commentary, GE seems to have a good chance of growing its free cash flow margin to 10% or even a bit higher by mid-decade. That could support annual free cash flow of roughly $10 billion.
This highlights why the improvements in GE's power and renewables segments and the high likelihood of a full recovery at GE Aviation are so significant. Today, investors are mainly focused on whether or not General Electric will meet its 2023 targets. Yet those goals actually represent just an intermediate step along the path back to full health.
