EUR 850.00 For Business Accounts Only

Morningstar | No News Is Good News at GE as CEO Culp Steers the Ship Back on Course

Nothing in General Electric's first-quarter results materially alters our long-term view of the firm, and we expect to slightly raise our fair value estimate to about $12.60 per share, entirely due to the time value of money in our valuation methodology. We maintain our narrow moat, stable trend, poor stewardship, and very high uncertainty ratings. As the shares once again reach a 3-star rating (rising over 7.5% in premarket trading), we no longer find the risk/reward balance as attractive. The first quarter, which historically is GE’s weakest, came in slightly better than our expectations, but this mostly relates to timing. However, we are encouraged that management reaffirmed its guidance.

The quarter revealed no new surprises after the outlook call in March, and management rightly identified the Boeing 737 MAX as a new risk. This is a real threat to GE’s business, given that 60% of the company's value comes from GE Aviation, but as of now, we think the groundings could be a blessing in disguise. While CFM (the GE Aviation and Safran joint venture) is on track to deliver at least 1,800 Leap engines in 2019, deliveries lagged earlier this year (about four weeks behind schedule), and CFM has struggled to ramp up deliveries to keep up with Boeing 737 MAX (single-sourced) and Airbus A320neo production rates.

We have been concerned about the Boeing 737 MAX and the timing of receivable collections, and management's response came on the April 30 call: The situation remains very much in flux. Production plans have not changed, but management confirmed that the timing of cash flows could be affected by collections of receivables from Boeing. GE shares 50/50 exposure with Safran, but management quoted a EUR 200 million exposure in the second quarter if Boeing’s current production rates remain the same. That said, GE’s full-year guidance already bakes in some timing contingencies.

Total consolidated industrial free cash flow came in at negative $1.2 billion, which is better than we expected, but the timing relates to inventory build for second-half volume and progress collection reductions in GE Renewable Energy and GE Power, as well as some other timing issues. At a high level, Aviation and Healthcare realized continued order strength, with Aviation up 7% year over year and Healthcare up 5% year over year. GE Power orders declined 14%, with sales down 22% and segment profits down 71%. The troubled industrial segment's results came in materially better than our expectations (we project negative GE Power segment profits), once again due to timing. Renewable Energy did take it on the chin, with segment profits going negative (and below expectations) given the wind-down of the production tax credit cycle.

We’re glad that management is keeping expectations conservative for the unit. The Power turnaround is still very early, echoing CEO Larry Culp’s often-repeated comment that "This is a game of inches." Nevertheless, we’re encouraged by Culp’s comments that as GE has made plant floor and job site reviews, there are plenty opportunities for improvement as GE reemphasizes a focus on lean manufacturing. We think this shuts down the bear case that GE Power can no longer rightsize its footprint from this baseline. Culp pointed out that GE booked about 4.5 gigawatts of equipment orders of gas power in the quarter at good margins, which we think echoes our thesis that gas power still has a place as part of the world’s power mix.

Finally, GE Capital revealed no new surprises. GE Capital finalized its $1.5 billion WMC settlement with the U.S. Department of Justice (which came in better than our initial expectations last year), as well as $1.9 billion for its insurance contribution as expected. Overall, we reaffirm our thesis that GE's valuable assets are worth more than the market price and GE is now in the hands of a capable and able manager.