Investors are likely keen to know more about General Electric's (GE +2.24%) first-quarter earnings as they look for indicators that the company is on track with its turnaround efforts. Let's break out five key markers and commentary that shareholders should be looking out for from the earnings report, set for release on Tuesday.
1. Is the full-year outlook still on track?
The case for investing in GE rests on the idea that the company can achieve management's aim of expanding free cash flow (FCF) margins to high single-digit percentages by 2023. GE Aviation (engines and spares) will have to recover in line with expectations in order to get there.
Image source: Getty Images.
At the same time, GE Healthcare equipment and service revenue needs to overcome the disruptions caused by the pandemic. Meanwhile, the main aim in the power and renewable energy segments is to get both to the kind of earnings margins enjoyed by their peers.
The first step along the way is to meet or beat management's 2021 guidance.
| Metric |
2021 Management Outlook |
|---|---|
|
Revenue |
Low-single-digit percentage growth |
|
Industrial margin |
250+ basis points growth* |
|
Adjusted earnings per share |
$0.15 to $0.24 |
|
Free cash flow |
$2.5 billion to $4.5 billion |
Data source: General Electric presentations. *100 basis points equals 1%.
The key thing to look out for is the FCF guidance, specifically whether management will adjust the range. CEO Larry Culp has acquired a reputation for being cautious with FCF, so don't be surprised if the low end of guidance is raised.
In terms of commentary, investors should look out for what management says about the sustainability of working capital improvements in an improving revenue growth environment. Management estimates that two-thirds of its FCF in 2021 will come from working capital improvements. It's one thing to collect cash better and run down inventory (both working capital actions) when end demand is falling (many industrial companies do this). It's another thing when revenue is growing -- GE's inventory will need to be rebuilt and receivables will go up.
2. How is the Aviation recovery going?
The key questions all aerospace investors are asking are when activity will return to 2019 levels and what the shape of the recovery will be.
One way to monitor GE's performance is to look at its aviation spares rate, which it defines as the "commercial externally shipped spares and spares used in time & material shop visits." The spares rate will go up as more flights take place, but it could come under pressure if airlines start picking up the pace of retiring old planes. The evolution of the spares rate is something to keep an eye on in 2021.
Data source: General Electric presentations, Chart by author.
Regarding commentary, it will be fascinating to hear about the potential impact on GE Aviation margin of retiring older planes. They tend to need more servicing, and their spare parts tend to generate higher margins for manufacturers.
3. Healthcare and 4. renewable energy guidance
In healthcare, the key focus is on when medical bodies will start ordering capital equipment again. Management expects low-to-mid-single-digit percentage revenue growth for the full year, with some margin expansion and FCF "flat to slightly up" on the $2.6 billion reported in 2020. Look out for commentary on imaging equipment sales trends.
The guidance is somewhat vague in renewable energy, with management calling for a "better" full-year segment margin than the negative 5.2% reported in 2020. However, full-year FCF is expected to be positive in 2021, with onshore wind expected to be margin positive.
Image source: Getty Images.
GE is in an exciting position in the industry because it has an opportunity to expand margin by continuing to work through less favorable legacy contracts, and it's growing its offshore revenue business -- the growth engine of the wind power industry in the medium term. The critical aspect to focus on is margin performance and management's guidance on margin.
5. Will Power performance remain mixed?
The segment's FCF was negligible in 2020, and management expects a similar figure in 2021. However, the segment's margin is likely to improve from the 1.6% reported in 2020.
While the headline guidance is somewhat disappointing, it's worth noting that GE is exiting the new-build coal power market -- an act that will create a drag on cash in 2021 and "probably" in 2022 as well, according to Culp.
Image source: Getty Images.
GE Power's performance has been mixed. Sales of its heavy-duty gas turbine, known as the HA, have been impressive and are helping GE overcome end market softness. Also, management has taken more than $1 billion worth of cost out of GE Power, but by Culp's admission, "services has been a challenge."
That said, management believes that power outages will increase in 2021, leading to a pickup in orders through the year. That's the key number to focus on.
General Electric's first quarter
All told, while the headline numbers from the first quarter won't be pretty (they are coming up against the pre-pandemic numbers from 2020), there's reason to believe GE can demonstrate underlying improvement. A revenue recovery in healthcare and aviation is the key, alongside ongoing margin improvement in power and renewable energy.
