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Morningstar | GE's Third-Quarter Earnings Preview: What We Can Expect From Larry Culp Tomorrow

General Electric reports earnings on Oct. 30, 2018, but we wanted to preview some of our expectations for new CEO Larry Culp. We believe Culp will successfully enact change by separating off noncore businesses, deleveraging the balance sheet, rationalizing costs, and freeing up cash. Over the next several years, we believe these actions should close the gap between the stock’s price and the firm’s intrinsic value. We maintain our fair value estimate of $16.10.

Like his predecessor, however, Culp has limited options and continues facing many of the same issues. These issues include secular weakness at Power, an unknown quantity of liabilities at Capital, and a balance sheet constrained with excessive interest-bearing liabilities. That said, we expect Culp will largely stick with the focus on Aviation, Power, and Renewable Energy. We do, however, expect changes in execution, like re-evaluating the timeline to separate out Healthcare. We believe Culp will implement appreciably similar aspects to the old Danaher playbook. Bears point out the Danaher Business System was purely acquisition oriented. We disagree. A large part of the strategy was focused on eliciting continuous improvement from its businesses, and we think improvements can be made to GE’s customer sales process as well as inventory management. Bottom line, GE can afford to trim some fat. For example, GE Power runs at about 55% efficiency to Siemens’ Power & Gas (as measured by profitability per headcount), even as GE has over 3 times more corporate expenses per unallocated employee.

Immediate actions we expect from Culp include cutting the dividend. Danaher only paid about a 3%-4% payout ratio during Culp’s tenure, and GE has paid out about $2.2 billion in dividends against negative industrial FCF of $1.4 billion year to date, with a recent guidance walk-back and potential bond rating downgrades underway. We also expect a 100-day plan to right-size Power and Corporate through heavy restructurings.

More long term, we expect the firm to ringfence legacy mortgage and insurance liabilities, potentially in a package deal with GECAS involving legal indemnifications. If Culp can rationalize costs in line with Siemens at both Power and Corporate and maintain Capital as a zero contributor (i.e. it neither loses nor makes money), then we see a clear path to $20 in the name. Assuming a kitchen sink scenario tomorrow (in addition to the known $23 billion goodwill write-down at Power), if the stock hypothetically were to fall to our 5-star price of $9.66, investors buying the stock would be buying wide-moat Aviation and Healthcare, attaching all of the firm’s liabilities, and would be essentially getting the rest of the businesses for free.