GE’s Big Worry Is a Virus, and That Counts as a Win

(Bloomberg Opinion) -- General Electric Co.'s biggest problem is now the coronavirus. And honestly, that's a victory for a company that's spent the better part of the last three years mired in idiosyncratic challenges largely of its own making.

GE hosted its outlook meeting on Wednesday and reiterated its expectation that its industrial businesses could generate as much as $4 billion in free cash flow this year, nearly double what they produced in 2019. That's despite the fact that GE now expects coronavirus knock-on effects to shave as much as $500 million off of its first-quarter free cash flow. The brunt of the pain – as much as $300 million – is being felt the aerospace division as airlines around the world cancel flights and companies ban non-essential travel and cancel events.

But the company also flagged a notable turning point: GE expects the long-beleaguered power unit to actually generate positive free cash flow starting in 2021 after years of negative numbers. The company said the renewable-energy unit – expected to burn more than $1 billion of cash in 2020 – is GE's “key focus” this year, echoing CEO Larry Culp's comments on a late January earnings call. To make that a priority would have been unthinkable a year ago when the larger, troubled power division had just announced a $22 billion writedown and was facing deepening losses. It's an encouraging sign that the business is  seeing decent enough progress that Culp can divert his attention elsewhere.

Part of what made GE's recent financial distress so incredible was that it first came to light at a time when most industrial peers were enjoying the benefits of the U.S. tax overhaul and a recovery from the oil-price-driven downturn of 2015 and 2016. While other manufacturers were later dogged by questions about the trade war, that was mostly just a footnote at GE amid concerns about the viability of a turnaround in its power unit and its bloated and unpredictable insurance liabilities. I don't want to belittle the risks from the coronavirus here because they are meaningful, but in general, the tone of this outlook meeting feels … dare I say, normal for an industrial manufacturer right now? Or at least as close to normal as a company that clings to financial complexity like a security blanket is going to get.

This being GE, there is always a risk of some kind of nasty surprise, but Wednesday's presentation brought none of those. In fact, we haven't had one in a while now and it feels like Culp is hitting his stride on a turnaround. GE had previously cited Boeing Co.'s grounded 737 Max as the biggest risk to its cash-flow guidance, but the companies have since reached an agreement on payment terms for both 2019 engines attached to parked planes that can't be delivered yet and those it produces in 2020 while Boeing works through a logjam of grounded jets. The question now is how much of a dampening effect the coronavirus will have on its progress.

Before Wednesday's meeting, GE shares had fallen about 13% since the beginning of February amid a broader market sell-off on coronavirus fears. For GE, the impact includes supply-chain disruptions, the sudden upheaval of a steady trend of aerospace traffic growth and the drop in interest rates. It's entirely possible that these issues  extend beyond the first quarter and that the cash impact over the course of the year is more significant. Supply-chain dislocations are predominantly hitting the health-care unit right now, but they risk ensnaring the rest of the company over time, while GE is seeing weaker China demand for certain products. It's fair to ask if GE, like its engine joint-venture partner Safran SA, is being too optimistic about the possible hit to lucrative spare parts and maintenance work in the aerospace division from the marked drop in demand. Planes bearing GE engines have seen 60% fewer departures out of China. GE is still calling for overall aviation free cash flow in 2020 to be flat to up relative to the $4.4 billion generated last year. 

Meanwhile, GE's pension obligations increase by about $2.3 billion with every 25 basis-point drop in the discount rate. The company assumed a 3.36% discount rate at the end of 2019 for its principal pension plan; yields on 10-year Treasuries dropped below 1% on Tuesday after the Federal Reserve announced a surprise 50 basi-point cut to interest rates. The company's long-term care insurance liability also varies with interest rates, which puts the relatively modest $1 billion pre-tax GAAP charge announced last year and the $100 million expected increase to statutory reserves announced in February in more concerning context. GE said it's monitoring testing of its insurance reserves, which isn't included in its 2020 outlook. While that liability appears to have stabilized and is less of a un-analyzable bogeyman than it was, it hasn't gone away.

To say GE has overcome all of its challenges would be a step too far. But when the CEO is devoting a significant chunk of time to issues that every other industrial company is talking about, too, that's as good a benchmark as any of progress.  

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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