GE Part 1: 18Q2 Results

General Electric reported disappointing 2018 second quarter GAAP earnings attributable to shareholders of $736 million or $0.07 per share, down 30% from $1.03 billion or $0.10 per share last year.  Adjusted (Non-GAAP) EPS, according to the company’s definition, was $0.19 per share, down 10% from $0.21.  Non-GAAP EPS exceeded consensus estimates by a penny.

GE’s share price fell 4.4% on the day of the earnings announcement (7/20) and has been treading water for the past week.  Yet, management said that the quarter was in line with expectations.  The Aviation and Healthcare businesses posted solid results; Power remains challenging.  Management reported $300 million of industrial structural cost reductions for the quarter and $1.1 billion year-to-date, more than halfway to its full year goal of $2.0 billion.  Excluding dividends paid last year by GE Capital to GE, GE’s year-to-date free cash burn eased versus last year.  The company expects to end the year with more than $15 billion of Industrial cash and investments, compared with $14.7 billion at quarter’s end.

Industrial revenues increased 4% to $28.7 billion, due primarily to the acquisition last year of Baker Hughes and the impact of foreign currency; but organic revenues declined 6%.  Industrial operating margin fell 160 basis points (bp) overall (to 10.4%); but was down 80 bp organically.  Margin declines in Power and Aviation (due to the launch of the LEAP engine) were partially offset by a higher operating margin in Healthcare and lower corporate expenses.  Orders for the quarter were up 11% versus last year, with gains in Oil & Gas, Transportation, Aviation and Healthcare offset by declines in Power, Lighting and Renewable Energy.

Power.  GE sees global demand for natural-gas fired power plants at less than 30 gigawatts in 2018, consistent with its 18Q1 outlook.  Deals continued to be delayed.  Orders fell 26% in the quarter, with contracts signed for only seven gas turbines versus 24 last year. Unit sales were down commensurately, falling to seven from 21.  With the decline in backlog over the past year, Power is receiving lower progress collection payments on current production.  It also booked fewer Advanced Gas Path upgrades in the quarter and has yet to win more transactional service business.  Management remains focused on reducing its footprint to balance global manufacturing and service capacity with anticipated market demand.  It is also seeking to reap as much business as possible from its large installed base, which generates roughly a third of the world’s electricity.

Renewable Energy.  Orders of onshore wind turbines fell 15% in the quarter, following a big first quarter surge; but management still sees strong global demand.  Pricing pressures moderated in the quarter but remain challenging.  Management expects volume to ramp up in the second half, which should also lift profit margins.

Oil & Gas.  Revenues increased 85% to $5.56 billion due to the Baker Hughes acquisition.  On a combined business basis, revenues were up 2%.  Segment profit as reported declined 39.2% to $73 million; but increased 85% to $222 million, excluding restructuring and other charges.  Orders advanced 9% to $6 billion on a combined business basis.

BHGE’s shorter cycle businesses are performing well.  Growth in drilling services outpaced the increase in the rig count.  But longer cycle businesses, such as offshore, are only just now beginning to show signs of recovery.

LNG is another long-cycle business and a strategic priority for BHGE.  The company will supply six gas turbines and compressors for a third train at Cheniere Energy’s LNG liquefaction facility in Corpus Christi.  That is the first final investment decision made on a major U.S. LNG project since 2015.  BHGE expects to see more LNG projects move forward over the next few years.

As BHGE pursues new business, it is also focused on achieving $700 million of merger synergies this year.  It delivered $189 million of synergies in the second quarter, bringing its year-to-date total to $333 million.

During the quarter, BHGE paid GE $439 million, including a quarterly dividend of $125 million and share repurchases of $313 million.

Aviation.  Orders surged 29% to $9.5 billion with gains across all aircraft engine types.  The $22 billion of orders from the Farnborough air show were not included in order totals.  Revenues increased 13% to $7.5 billion and segment profit was up 7% to $1.5 billion.  The decline in segment profit margin was due to the ramp up of LEAP engine production.  Margins should therefore improve as LEAP gains greater manufacturing efficiency from increased production scale.  Aviation shipped 250 LEAP engines in the quarter, up more than three-fold from 69 last year.  The segment is about one-month behind plan on the LEAP ramp-up, but still intends to meet its production goal of 1,150-1,200 LEAP engines for the year.

Healthcare.  Revenues increased 6% to $5.0 billion and 4% excluding acquisitions and FX.  Orders were up 7% to $5.3 million.  A 100 bp increase in profit margins raise boost Healthcare segment profits by 12% to $0.9 billion.  The segment is seeing high single-digit growth in emerging markets and mid-single-digit growth in developed markets.

Transportation.  Transportation revenues declined by 13% to $0.9 billion.  Locomotive unit sales fell by 55% to 54 units, but services, mining and other revenues, which account for nearly 80% of the segment total were essentially flat.  Segment profits fell by 15% to $155 million.  Orders of $1.1 billion surged 42%, led by a four-fold surge in locomotive orders from 26 units to 115 units, on another large Northa American railroad order, raising the half-year total from 63 to 457.  Management had originally expected Transportation to post a 25% drop in profits in 2018.  Although it still looks like profits will be down, the business should show meaningful sequential improvement in the second half of 2018.

Free Cash Flow.  The company reported adjusted Industrial free cash burn (a Non-GAAP measure) of $1.7 billion for the first half of 2018, a modest improvement over the 2017 first half burn of $2.4 billion.  For 2018, management still expects adjusted Industrial free cash flow of $6 billion, at the lower end of its original guidance of $6-$7 billion.

Outlook for 2018. With 18Q2 results in line with company expectations, management reaffirmed its adjusted EPS outlook of $1.00-$1.07, but said that results will likely come in at the low end of the range.  Analysts’ skepticism about whether GE can deliver is reflected in the current consensus forecast of $0.95.  With adjusted EPS of only $0.35 in the 2018 first half, GE will have to earn at least $0.65 in the second half in order to meet its guidance and that certainly seems like a stretch, given the company’s relatively weak performance over the past four quarters.

Yet, achieving guidance does not seem impossible.  Profits in Power will probably continue to slide, given the continued weak demand outlook; but GE should see improvement across most of the other businesses.  As already noted, management expects a volume ramp in Renewable Energy which should lift operating margins from more efficient absorption of fixed costs, despite ongoing pressure on pricing.  The rebound in oil prices has sparked a pick-up in drilling demand, with offshore activity finally beginning to show improvement.  Aviation should deliver solid growth in revenues and profits as LEAP production continues to ramp.  Healthcare still sees strong growth in emerging markets and solid growth in developed markets.  With higher volume and productivity profits should continue to expand at a low double-digit rate.  On balance, while softness in the first half will still likely result in GE posting lower Industrial profits in 2018, improved second half performance looks like a pretty reasonable bet.  However, most of the improvement will be weighted toward the fourth quarter.

July 29, 2018

Stephen P. Percoco
Lark Research
839 Dewitt Street
Linden, New Jersey 07036
(908) 448-2246

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