GE Making Progress, But Significant Challenges Remain

Wide-moat

At 4 stars, GE’s shares look undervalued, and patient investors with long time horizons may be rewarded as Flannery’s long-term vision for a healthier GE crystallizes. However, worsening power markets, an opaque GE Capital, and a newly disclosed SEC investigation into GE Capital’s insurance reserves, as well as revenue recognition and controls for GE’s contract assets, are factors that suggest investors should consider a wider margin of safety before putting new money to work.

GE generated $116 billion of industrial revenue in 2017, flat on an organic basis as declines in power, oil and gas, transportation, and lighting offset strong sales in renewables, healthcare, and aviation. Adjusted industrial operating margins tumbled 190 basis points year over year to 12.1% for 2017; however, excluding sharp declines in power and oil and gas in the fourth quarter revealed 200 basis points of operating margin expansion, suggesting GE’s portfolio still holds plenty of promise over the long run under better management.

Industrial cash from operations beat 2017 guidance, coming in at $9.7 billion on an adjusted basis, versus $7 billion. Flannery appears to be demanding discipline across the portfolio in areas that can be controlled, such as tighter working capital management, structural cost reduction, and enhanced manufacturing efficiency. Yet, worsening demand in power markets is outside of GE’s control. While we’re pleased to see new head of power Russell Stokes laser focused on fixing 2017’s concerning declines in high-margin aftermarket service revenue, we suspect this tough battle will only become more challenging in a depressed power market environment.

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