Just a few years ago, it would almost have been unthinkable to describe General Electric's (GE 0.94%) power business as its best performer, but that's where things stand now. While the other three segments (healthcare, aviation, and renewable energy) have all suffered significantly with supply chain pressures in 2022, GE Power is on track for its full-year guidance. It's an impressive performance, and GE investors will need it to continue to help ensure the successful execution of its breakup plan. Here's why.
Why GE Power matters
Ongoing performance at GE Power is particularly important for three key reasons, and they all relate to the upcoming breakup of the company. As a reminder, GE will spin off GE Healthcare in early 2023 and then GE Vernova (a combination of GE Power and GE Renewable Energy) in early 2024.
Unfortunately, GE Renewable Energy is not in great shape right now (it's currently generating losses), and GE Vernova will need GE Power to do more than its fair share in the next 18 months:
- The turnaround at GE Power serves as a template for how GE Renewable Energy needs to restructure, and the latter will be led by the same person who was instrumental in the former, GE Vernova CEO Scott Strazik.
- GE Vernova will need GE Power's earnings to help ensure a successful spinoff and reduce the absolute level of debt it can take on board when the spinoff happens.
- Management will need GE Power's earnings and cash flow to support the turnaround in process at GE Renewable Energy.
As you can see above, it isn't just about GE Power; the whole of GE needs the business to perform well. It's on a good track at the moment, with management confirming expectations for low single-digit revenue growth and $1 billion to $1.2 billion in operating profit in 2022. It's an outlook in line with the guidance given during the investor day presentation in March. For reference, management guided for $1 billion to $2 billion in GE Power segment profit for 2023.
GE Power has come a long way
To understand the significance of the turnaround at GE Power, you must appreciate the significant change in end market conditions. In a nutshell, the growth of renewable energy has lowered demand for new gas turbines -- GE Power's key product, from which it generates higher-margin services revenue over a 15- to 20-year period.
The challenge faced by GE Power can be seen in the following chart of GE's heavy-duty gas turbine sales in terms of units. It reflects the slowing demand for gas turbines that created overcapacity in the industry and a subsequent collapse in profit margins. As such, GE Power went from $5.1 billion in profit and mid-teens margin in 2015 to a business losing $1.1 billion at the low point in 2018. Given that GE Power is forecast to generate $1 billion to $1.2 billion in profit in 2022, even though end demand hasn't improved, speaks volumes for Strazik's implementation of CEO Larry Culp's focus on initiatives to improve performance, notably in its power services operations.
It also speaks to the ability to work through less profitable contracts while restructuring the business for a new growth reality -- a playbook that GE Renewable Energy is following now.
Management believes GE Power is a low-single-digit revenue grower over time -- a realistic assumption given the ongoing importance of gas power for electricity production. If the segment can continue its growth and profit margin trajectory, then the GE Vernova spinoff will be better received by investors. As such, investors will be focused on management's commentary on potential earnings in 2023, not least to offset weakness at GE Renewable Energy and buy time to restructure the latter.
You could drive a bus through the current guidance of $1 billion to $2 billion, and investors will be hoping for something closer to the high end of the range ahead of the spinoff in 2024. Given the improvements in the underlying gas turbine business over the last few years, there's a reason for optimism that that scenario is possible.