General Electric: Is One Good Quarter Enough?

Source: Investing.com

After all, General Electric crushed Wall Street estimates in the quarter. Adjusted earnings per share were more than double analysts’ consensus; revenue was 7.3% higher. And the good news extends beyond the headlines.

There’s a more skeptical reaction, however. The quarter was excellent, yes, but GE’s earnings in particular are notoriously unreliable. Full-year guidance was left largely unchanged.

More broadly, this is a company that has disappointed for years. GE stock, adjusted for its reverse split executed last year, is up 5% — total — from where it closed on March 1, 2009, five days before the market bottomed after the financial crisis. The S&P 500 has rallied 433%.

One quarter alone can’t change that 13-year narrative. Then again, GE has to start someplace.

It’s important to view the Q2 report through the lens of what General Electric will be, not just what it is.

And what GE will be is three separate companies . The company, in fact, recently announced the names of the three businesses: GE Healthcare, GE Aerospace and GE Vernova (the former power and renewable energy businesses).

Most of the value in the three companies is going to come from healthcare and aviation. Those are the crown jewel businesses. GE Power has been challenged almost since General Electric acquired France’s Alstom (EPA:ALSO) back in 2015, in one of the worst acquisitions of the decade. Renewable energy has some long-term potential, but remains unprofitable.

One clear positive from earnings is not just that GE topped expectations, but how it did so. Aviation impressed, with 26% revenue growth, suggesting a continued recovery in that cyclical business . Notably, it was recurring revenue, not necessarily product sales, that drove the strong results, which suggests GE Aviation can manage through a recessionary environment that pressures travel spending.

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Healthcare numbers were light, with profit down 19% and revenue up just 1%. But supply-chain problems, lockdowns in China and cost inflation provide some justification for the results. Overall, healthcare — probably the most valuable of the GE businesses — given its defensive nature, seems to be in reasonably good shape.

The biggest disappointment in Q2 was in renewable energy. GE had guided for a recovery in the second half of this year, but management admitted on the conference call that such a recovery wasn’t on the way. GE plans more cost cuts, but even in that context the news there looks grim: Renewable energy has generated $14.4 billion in revenue over the past four quarters, while posting a segment loss of more than $1.3 billion.

Of course, if one of the units was going to post a soft quarter, it would be best if it was not aviation or healthcare. Almost certainly, GE Vernova will be the least valuable of the three businesses.

Again, the strength in the quarter doesn’t necessarily read across to the full year, by GE’s own admission. After Q1 results, management pointed to the lower end of the 2022 outlook originally given in late January following the fourth-quarter report. After Q2, despite the beat relative to consensus, management said largely the same thing — with one exception.

That exception seems important. GE pulled down free cash flow guidance for this year by about $1 billion. Commentary on the post-earnings call suggested that 2023 results too will be pressured.

That guidance does seem concerning in the context of GE’s long history. There’s long been a gap between earnings and free cash flow. Earnings can be influenced by accounting choices, particularly for a business as complex as GE Capital (assets of which incredibly still are being run off). The ‘one-time’ effects excluded from adjusted earnings too can be gamed; restructuring charges, for instance, seem to recur every single year.

Free cash flow, however, is much less affected by management decisions; it’s simply a measure of the actual cash coming into the business. For years, skeptics pointed to low free cash flow as a reason to sell GE stock, even while GE at times looked cheap on an earnings basis. Those skeptics likely see the reduced free cash flow outlook as simply more of the same.

But even with the lower guidance, there’s a case that the fundamentals here are starting to work. (Ironically, that’s not true looking at adjusted earnings, which likely don’t come in much above $3 per share this year.) Free cash flow of $4.5 billion this year, and perhaps $6 billion-plus next year (assuming a $1-billion reduction from the prior outlook for next year) can support a current market cap just shy of $80 billion.

That’s particularly true if aviation and healthcare are performing well. At least in Q2, they were.

All told, it’s not hard to view GE stock as a buying opportunity after Q2 results. Despite a highly unfavorable operating environment, the company posted solid results. The concerns surrounding free cash flow are reasonable in the context of supply-chain issues and weakness in the renewable energy business.

Valuation is reasonable. The business is not the same cyclical industrial it used to be. And it does seem like GE, following the appointment of Larry Culp as chief executive officer back in 2019, finally is on track.

At the same time, however, that history weighs. Over the past 13 years, GE has raised expectations on a number of occasions. Each time, it has disappointed. It’s going to take more than one quarter to convince investors that this time truly is different. But if GE can do so, there’s some big upside ahead in GE stock.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.