General Electric's (GE 0.73%) latest investor update left Wall Street concerned that the industrial giant's third-quarter report might not be as positive as many had expected. Those worries don't just extend to its anticipated Q3 numbers, but also to the guidance and commentary management will give regarding near-term conditions.
The importance of each segment
For a diverse operation like GE, it's a good idea to break matters out by individual segments, not least because the update included something about each of them. The table below shows the relative importance of each industrial business.
For reference, management's game plan is for GE Aviation to return to its former glory in line with a recovery in commercial aviation. Meanwhile, GE Healthcare should remain a solid earnings and cash flow generator, and management plans to buff up the margins of GE Power and GE Renewable Energy through improved execution.
The recent update from VP of Investor Relations Steve Winoker doesn't indicate anything that throws those plans off course -- management is still targeting a free cash flow margin in the high-single-digit percentages by 2023 -- but there may be some turbulence along the way.
In commercial aviation, Winoker noted the impact of the Delta variant surge and fresh travel restrictions in August, but said that "we currently don't foresee a change to our shop visit expectations that we have provided" given "lag between departures and shop visits." If that outlook is correct, the company's all-important commercial aviation aftermarket sales should hit expectations in 2021. That said, if the pandemic has a further negative impact on flight departures, it will be reflected in declining shop visits in the future.
Of more immediate concern, Winoker said that the supply-chain challenges that hit its military business in the second quarter persisted into the third quarter. Moreover, GE took $400 million in non-cash charges on a contractual service agreement in the second quarter and expected further charges -- though lower ones than in Q2 -- in the third quarter due to reviews.
So far, so good. For GE's finances, its commercial aviation revenue is key, and investors will be happy if it meets expectations, while the charges will be non-cash items. However, the state of its military business is something investors will want to watch, as is the potential for a slowdown in the recovery of flight departures.
The most concerning part of the update came when Winoker declared that supply-chain challenges connected with the pandemic meant that its healthcare business would come under "sustained pressure" in the third and fourth quarters. Moreover, he said, the "challenging environment" will continue through the first half of 2022.
On the one hand, Winoker reiterated GE's full-year guidance for low-to-mid-single-digit percentage revenue growth. On the other, the forecast range is pretty wide for a relatively low growth business, and estimates for 2022 may have to be lowered due to the update on trading conditions.
That's a concern given the importance of the healthcare segment's cash flows to the industrial company.
The least impacted segment of all, GE Power, will see sequentially lower margins in the third quarter. Still, that's not uncommon as there are generally fewer power outages in the third quarter (and therefore lower services revenue for the segment) than there are in the second and fourth quarters. So on a positive note, Winoker reiterated confidence in the previously proffered guidance for a high single-digit percentage profit margin from the segment for the full year.
It was slightly disappointing that Winoker didn't reiterate CEO Larry Culp's commentary from the second-quarter earnings call concerning gas power services being likely to "do better than that low single-digit revenue'' guidance at the start of the year. However, this may well be just conservatism on management's behalf.
GE Renewable Energy
Finally, Winker reiterated what management said on the last earnings call regarding the possibility of risk to orders and cash flow from potential changes to the U.S. wind production tax credit (PTC), which is currently due to expire at the end of 2021. An extension of the PTC could hurt GE's near-term orders as customers might defer their spending. However, such an extension would be good for the segment over the medium term.
Interestingly, there was no mention of any margin pressures coming from increased raw material prices or supply-chain issues. That's somewhat surprising as its two biggest rivals, Vestas and Siemens Gamesa, both downgraded their revenue and margin guidance over the summer.
What it all means to GE shareholders
The third quarter could be bumpy, but GE's aviation and healthcare issues look temporary and will likely resolve in the coming quarters. In addition, the power business is trending well. As for renewable energy, the fact that Winoker refrained from talking down expectations based on cost and supply-chain pressure should be viewed as a plus, while the potential for a PTC extension is probably good news over the medium term.
All told, investors shouldn't be surprised if GE doesn't raise guidance on its next earnings call, but they can reasonably expect the company to remain on track for its medium-term goals.