Before Larry Culp took over as CEO of General Electric (GE -1.75%) in 2018, the company had a reputation for overpromising and underdelivering. The two previous CEOs left the company clinging to guidance that it wasn't going to meet.
But since then, Culp, ably supported by chief financial officer Carolina Dybeck Happe, has changed that perception, and the company is now known for exceeding guidance that initially looks conservative. It's a key consideration when looking at GE's latest fourth-quarter earnings results. Here's why.
Earnings weakness, excellent guidance
That subheading pretty much sums it up. I'll get to the guidance later, but first, the revenue miss. GE faced plenty of headwinds in the fourth quarter, and it significantly missed the revenue guidance given in the third quarter. On the other hand, GE's key guidance for 2022 puts it slap bang in the middle of the fairway where it needs to be to achieve its aims.
GE's cash flow beat expectations, again. Image source: Getty Images.
Back on the third-quarter earnings call, management told investors that full-year GE Industrial organic revenue would be flat on a year-over-year basis. However, it came in with a decline of 2%. It's essential to reflect on just how big a number that is. Digging into the details, GE's industrial organic revenue in 2020 (which strips out foreign currency effects and asset sales) was $71.72 billion and the full-year 2021 figure came in at $70.19 billion. Hence, GE's revenue miss was around $1.5 billion in the quarter.
Why GE missed revenue guidance
GE is definitely not the only industrial company to report revenue issues in the fourth quarter. In fact, two of its key rivals have already done so in January. In healthcare, Philips stock slumped after the company alerted investors to a revenue shortfall due to hospitals delaying installations; and a renewable energy rival, Siemens Gamesa, recently cut its outlook, too.
In both cases, it was a question of ongoing supply chain issues, exacerbated by the resurgence of COVID-19 cases. Moreover, GE's case is further complicated by the extension of production tax credits (PTC) in its core U.S. market -- the extension reduces the incentive for customers to bring orders forward.
In addition, during the earnings call, Culp talked of being more commercially selective on orders in the fourth quarter, notably in power and renewable energy -- in other words, a willingness to forgo revenue growth in favor of ensuring profitability. Given that Siemens Gamesa slashed its margin outlook (the midpoint of the new range implies a loss), GE's actions in the quarter make sense. Soaring costs for equipment are putting pressure on wafer-thin margins in the industry.
Image source: Getty Images.
In GE's defense, it's worth pointing out that overall, its industrial adjusted organic margin did expand more than expected to 6.9%, compared to implied guidance of 6.5%. In addition, the all-important full-year free cash flow (FCF) figure came in at $5.1 billion, compared to guidance of $3.75 billion to $4.75 billion.
General Electric's 2022 guidance
You can only grow FCF so much without revenue growth, and the fact is, GE missed on revenue guidance. Given that the full-year 2022 headline guidance and assumptions are very positive, the miss is a concern. A few notes on the headline guidance:
- Organic revenue to grow in the high single digits.
- Adjusted organic profit margin to expand 150 basis points (where 100 basis points equal 1%).
- FCF of $5.5 billion to $6.5 billion.
The FCF guidance is particularly important as it puts GE well on the way to the $7 billion 2023 target that Culp has told the market he's aiming for to ensure the breakup plan's success.
The underlying assumptions for 2022:
- GE Aviation revenue to grow 20%.
- GE Healthcare revenue to grow by the low to mid-single digits.
- Revenue growth at GE Renewable Energy and GE Power.
- Earnings and working capital improvements (especially lower inventory) "will enable GE to achieve its free cash flow range in 2022."
In a nutshell, GE needs a lot of things to go right in 2022 to hit its guidance. For example, it requires the healthcare orders to come back and no more significant issues with the pandemic hitting commercial flight departures. In addition, it needs the supply chain pressures to ease, enabling more profitability at GE Renewable Energy.
Image source: Getty Images.
Buy General Electric stock in 2022?
To buy GE stock, you have to believe that the supply chain issues will ease through 2022 and that management has enough credibility in the bank to be trusted to meet its guidance.
History suggests the supply chain issues will ease over time, and GE certainly isn't alone in expecting they will in the second half. Moreover, note that part of the fourth-quarter revenue miss is because GE isn't chasing less profitable contracts in power and renewable energy.
Turning to the credibility question. GE has an excellent record of beating FCF guidance under Culp, including in the fourth quarter of 2021. As such, he should be given the benefit of the doubt here.
