Industrials

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

(Updated )

And so an era ends.

General Electric Co. on Friday reported its last batch of quarterly results before CEO Jeff Immelt steps down, and it appears he will be going out without a disaster, if not with a bang. Investor anxiety had been mounting as Immelt's earlier-than-expected retirement announcement sparked fears of looming guidance cuts, an earnings reset or even a dividend cut. The $232 billion maker of jet engines and MRI machines had no nasty surprises of that caliber to deliver -- but it wasn't reassuring either.

In Need of a Win
GE hasn't gotten a positive reception from investors on its earnings since 2015
Source: Bloomberg

GE reported better second-quarter adjusted earnings per share than analysts had expected, in its second straight positive surprise of the year. Analysts noted that much of that beat came from a lower tax rate and a bigger-than-expected contribution from the remaining GE Capital assets, as opposed to a true operational improvement. That said, a 2 percent gain in organic industrial sales despite a slow-growth economic backdrop was encouraging, and should put the company well on its way to meeting an aggressive overall target for the year of 3 percent to 5 percent.

GE maintained its profit outlook for this year, but indicated it would come in at the lower end of the $1.60 to $1.70 range. It said nothing in its press release and slide presentation about its much-doubted $2 goal for 2018 EPS. (Immelt in May acknowledged the $2 number was on the ambitious end given the ongoing challenges in resources markets and that additional cost cuts would likely be necessary to meet that goal.)

Of course the most important metric on everyone's mind, particularly in light of those dividend worries, was GE's cash flow. CFO Jeff Bornstein looks vindicated in his prediction for improvement after GE's large shortfall relative to its own expectations last quarter, which it blamed in part on delayed customer payments. Industrial cash flow from operating activities (excluding deal taxes and pension) improved to $1.5 billion for the period, compared with negative $1.6 billion in the first quarter. That said, the company is still coming out of the first half of the year with a negative number.

Uphill Battle
GE has a long ways to go to meet its 2017 cash flow targets.
Source: Company reports, Bloomberg
Note: Excludes deal taxes and pension

GE's cash flow is naturally weighted toward the second half of the year, but even in that context, meeting its 2017 goal of $12 billion to $14 billion in industrial CFOA will require some heavy lifting. GE did reiterate that goal in its earnings materials on Friday, but it didn't give a specific number for expected cash flows in the second half of this year, saying simply that it will be better than the $11.1 billion it brought in during the comparable period in 2016. That could mean it reaches its goals, or it could mean the company falls short.

Range Bound
Analysts' average target price has drifted back down toward where it was at the start of 2015 -- before GE announced the divestiture of some $200 billion in finance and real estate assets
Source: Bloomberg

In this lame duck quarter, GE's results shouldn't exacerbate investors' concerns, but they also shouldn't do much to abate them. A dividend cut seems unlikely. Even JPMorgan Chase & Co. analyst Steve Tusa -- who has by far the lowest price target among Wall Street followers of the stock -- expects the payout will be preserved given incoming CEO John Flannery's stated commitment to it. But GE's cash conversion is still poor relative to peers as it works through large investments connected with the launch of its H turbine, Leap jet engine and digital program. It's also facing meaningful restructuring bills and a staggering underfunding of its pension, which stood at about $31 billion at the end of 2016. The common thinking is that at the very least the company's buyback will have to be reduced, depriving GE of an EPS boost it could really use.

Fun with Numbers
GE has the widest discrepancy between its adjusted results and GAAP numbers among major industrial companies
Source: JPMorgan analyst Steve Tusa

GE said incoming CEO Flannery would put out a report in mid-November outlining his thoughts on capital allocation priorities, the state of the company's business and a 2018 outlook. The lack of an explicit confirmation of the $2 goal on Friday would seem to affirm analyst speculation that some kind of reset in the way GE thinks about earnings is looming. Some have wondered if it may move closer toward GAAP accounting in an effort to appease investors who have grown indignant at a steady stream of one-time adjustments and wonky calculations that don't compare to peers' reporting standards.

Immelt will leave investors with a modicum of a win. But Flannery still has his work cut out for him.

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

(This story was updated to add earnings guidance from GE's conference call in the fourth paragraph.)

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

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