A General Electric Co. (GE) logo sits on an M601 turboprop aircraft engine during assembly at the GE Aviation Czech s.r.o. plant in Pragu. (Photographer: Martin Divisek/Bloomberg)

GE’s Power Business Is ‘Ground Zero’ as Market Awaits Rebuild

(Bloomberg) -- General Electric Co. is set to close out one of its worst years since the financial crisis, and 2019 may be another precarious one.

The challenges are many and over the next few months, new Chief Executive Larry Culp will have to revamp GE’s power business, sort out liquidity problems arising from cash flow shortages and soaring financial liabilities, and resolve regulatory investigations. Those are tall orders even in a bullish or stable market, and tougher still in the midst of a possible economic slowdown, volatile oil prices and questions surrounding U.S.-China trade.

“Their biggest business that is under fire is the power business,” RBC Capital Markets analyst Deane Dray said in a phone interview. “The ground zero of their operating challenges are in power.”

The company’s power business has been plagued by slack demand for gas turbines, technical glitches and shrinking market share. As part of a broader transformation, Boston-based GE has announced plans to split the power business into two units, and will write down about $23 billion of goodwill tied to the segment. “Everything associated with gas turbines are now in the ‘good bag’ and the rest in the ‘bad bag’ that they will look to divest,” Dray said.

For a company that’s trying to cut the fat and narrow its focus to power generation, aviation and renewable energy markets, the question for 2019 is whether the worst in power is over -- or at least close.

Analysts have few answers. Joseph Ritchie of Goldman Sachs expects 2019 to be another “down year” for power sales, while JPMorgan’s Stephen Tusa, a long-time GE bear, estimates power will break even on free cash flow -- but not until 2023. “To get there, we continue to see the need for heavy restructuring in each of the next two years,” Tusa wrote in a note to clients, noting that the key unknown is the pricing pressure faced by the business.

One of the first cracks in GE’s facade showed up in July last year when departing CEO Jeffrey Immelt told Wall Street that earnings would fall short of expectations, with crude and power markets weighing on results. And even after a staggering 73 percent wipe-out in the stock since then, analysts continue to see structural concerns in the power market.

“To be clear, many of the problems uncovered at GE are systemic in nature and were allowed to persist for over a decade,” RBC’s Dray said. “It will take time for Mr. Culp to stamp out the culture of mismanagement, fumigate the closet, and inject some much-needed transparency into GE’s historically opaque accounting practices.”

Culp was brought in as GE’s top executive in October -- replacing John Flannery, who had been in the role for just over a year -- with a directive to fast-track the company’s transformation.

Liquidity Concerns

According to JPMorgan’s Tusa, GE needs to cut about $65 billion in combined straight debt, soft liabilities, and pension obligations to get to “normal.” The analyst said that GE should raise about $25 billion in equity to address the liquidity issues, using it to fund the pension plan, while also contributing to other liabilities like insurance.

Selling non-core units should bolster the balance sheet and help shore up investor confidence. To that end, GE has begun moving in the right direction, with several divestments announced since Culp took the helm, including a plan to accelerate GE’s exit from Baker Hughes, selling a majority stake in software provider ServiceMax and unloading a portfolio of health-care equipment leases and loans.

“So long as GE is able to sell non-core assets, which continues with the announced disposal of ServiceMax, we see a clear path to balance sheet de-levering,” Wolfe Research analyst Nigel Coe wrote in a note Dec. 14.

Management should consider executing the sale of the company’s prospective stake in Wabtec -- the result of a deal with GE Transportation that’s expected to close early next year -- and more than half of its health-care business via split transactions as opposed to spinoffs, the analyst said. “This is the single, most visible way of tilting the conversation back to the fundamentals, calming down the credit markets, while soaking up what appears to be a very deep pool of sellers.”

And then there are the regulatory probes, over which even a practiced veteran like CEO has no real control.

All in all, 2019 will continue to look pretty bad before there’s even hope of it getting better.

“Flipping the calendar is not going to change anything,” RBC’s Dray said. “Though everyone wants to go ‘oh that was a nightmare, thankfully it’s over,’ all of that still carries into 2019, along with all the urgency.”

©2018 Bloomberg L.P.