According to reports, General Electric (GE -3.80%) is nearing a sale of its nuclear turbines business to France's Electricite de France (EDF) (ECIFY) for $1.2 billion. It looks like a relatively small deal on the periphery of GE's industrial empire, but its potential importance shouldn't be understated. If a deal goes ahead, GE investors have cause for optimism. Here's why.

A nuclear power plant.

Image source: Getty Images.

Why power matters

Tou have to go back to GE CEO Larry Culp's investor presentations in 2021 for some more context here. The free cash flow (FCF) and earnings discussion at the Alliance Bernstein event in early June are fascinating. During the discussion, Culp discussed the possibility of hitting $7 billion in FCF by 2023.

His argument assumed $10 billion of operating profit ($11 billion in industrial segment operating profit) to produce $7 billion in FCF after interest, taxes, and capital spending are taken out. The table below summarizes Culp's commentary on segment profits, and provides numbers from recent years.

GE Industrial Segment

Commentary on 2023 Segment Profit ($billions)

2020

2019

2018

Power

"call it $1 billion to $2 billion of op profit"

$274 million

$291 million

($1,015 million) 

Renewable Energy

"positive"

($715 million)

($791 million)

$140 million

Aviation

"$6 in Aviation"

$1,229 million

$6,812 million

$6,454 million

Healthcare

"call it $3.5, take the midpoint in Healthcare"

$3,060 million*

$3,737 million

$3,522 million

Data source: GE presentations.

It's no secret that a recovery in commercial aviation -- and with it a recovery in GE Aviation engine and engine aftermarket sales -- is the key to its recovery. However, note that the biggest improvement in earnings will come from the power segment outside of aviation. As such, it's a key swing factor in the company's prospects.

GE Power

The segment runs four discrete businesses organized into the company's Gas Power and Power Portfolio (GE Hitachi Nuclear, Power Conversion, and Steam Power). Gas Power sells gas turbine equipment and services, and contributed $12.7 billion of the overall power segment's $17.6 billion in revenue in 2020.

In general, management is making good progress in turning around profitability and FCF in the Gas Power business. For example, on the second-quarter earnings call, Culp noted that "we're in all likelihood going to do better than that low single-digit revenue guide that we talked about for Services" when discussing Gas Power's higher-margin services growth guidance.

A gas turbine.

Image source: Getty Images.

The remaining $4.9 billion in 2020 revenue from GE Power came from the Power Portfolio, with $3.7 billion of that coming from Steam Power. It's here that the potential EDF deal becomes relevant.

GE is exiting the coal business, and its stated plan is to shift steam power's revenue toward higher-margin services and nuclear business. The following table shows the guidance given during the investor outlook in March. GE selling its nuclear turbine business (steam turbines used in nuclear power stations) would leave the steam power business primarily a steam services business.  That's good news, because management believes steam services would have a high-single-digit FCF margin.

Indeed, during the last earnings call, CFO Carolina Dybeck Happe asked what steam power services' margin could be in 2023. She replied: "Service margins are always expected to be strong, and we expect them to be strong, probably slightly lower than gas."

As such, the sale of the nuclear (steam turbines) business would leave steam power (and the Power Portfolio) as a high-single-digit FCF services business. Together with the recovering Gas Power business (which is expected to have a high-single-digit profit margin in 2021 alone), GE Power would be well set to hit Culp's target of $1 billion to $2 billion in operating profit by 2023.

Steam Power Revenue Composition

2023Est

2021Est

2020

Services

65%

60%

55%

Nuclear

30%

10%

8%

Coal

"minimal"

30%

37%

Data source: GE presentations.

A turning point

The sale of the business would also mark a milestone in GE's transformation since Culp took over. GE acquired the business with its ill-fated purchase of France's Alstom energy assets, and a sale would represent GE extricating itself from a deal that's haunted the company ever since the ink dried.

The business manufactures the Arabelle steam turbine, used in a third of nuclear power stations worldwide, including EDF Energy. Therefore, it makes sense for EDF to try and buy it as part of a vertical integration play, particularly as the plant making the Arabelle is in France.

What it means to GE investors

A deal would make sense for GE investors, and help the company accelerate down its pathway to $7 billion in FCF in 2023. It would also allow GE Power's management to focus on its world-class turbine business and grow its higher-margin services revenue within it. That could make it a lot easier for GE to hit its medium-term FCF aims.