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Abu Dhabi, UAEWednesday 14 November 2018

GE's current pain may signal long-term gain

General Electric's changes show new CEO Larry Culp isn’t messing around and that the firm will look very different under his watch

A box of General Electric light bulbs. The firm may at last be heading on to a better path. Bloomberg
A box of General Electric light bulbs. The firm may at last be heading on to a better path. Bloomberg

It was another painful earnings day at General Electric (GE) but this time around, the company may finally be cutting deep enough to give its turnaround efforts a real chance.

In announcing its third-quarter results on Tuesday, GE also slashed its dividend to a nominal penny a share and said it would split its struggling power business into two units to accelerate operating improvements. GE reported a $630 million loss in its power segment for the quarter. That far exceeded analysts' expectations and dragged GE's overall results well below heavily reduced estimates. GE was mum in its press release and presentation slide deck on an update to its guidance for the full year, having already warned that it would fall short of a previous goal of $1 to $1.07 in adjusted earnings per share and $6 billion of industrial free cash flow.

The latest dividend cut comes almost exactly a year after former CEO John Flannery slashed the payout and admitted GE hadn't been generating enough cash for years to support it. I wondered at the time whether Mr Flannery had gone far enough, as the dividend still looked set to soak up a too-high percentage of the company's cash flow. The fact that more bad news is still trickling out of the company is a testament to why Mr Flannery was abruptly replaced with former Danaher CEO Larry Culp earlier this month.

Mr Flannery's heart was in the right place, but his operational turnaround efforts tended to affect changes only at the edges. Mr Culp, an outsider, isn't handcuffed by GE's past to the extent Mr Flannery was as a 30-year veteran of the company. Tuesday's changes show Mr Culp isn’t messing around and that GE will look very different under his watch. Analysts had been bracing for a dividend cut after GE disclosed a huge goodwill writedown in its power unit in conjunction with Mr Culp's hiring (it now says that will amount to $22bn). But it's still jarring to see a company that was for years known for its lucrative dividends almost eliminate its payout.

The dividend cut will save GE about $3.9bn a year, cash it very much needs to chip away at its bloated balance sheet and reduce its reliance on commercial paper. Moody's Investors Service at long last put GE's A2 rating and P-1 short-term grade on review for downgrade this month after it became obvious even for those in the cheap seats that the company's earnings before interest, tax, depreciation and amortisation and debt prospects were unlikely to be anywhere in the range of that level of creditworthiness for the foreseeable future. Standard & Poor's downgraded GE to BBB+ from A. The downgrades risk cramping GE's access to the commercial paper market.

The split of the power unit is an interesting strategy. It essentially creates a “bad bank” of GE's gas turbine and services businesses and, if not a “good bank,” then an OK-ish one out of the other assets in its power unit including steam, grid solutions, nuclear and conversion. GE's power business has been tripped up by a variety of factors including mismanagement and the pursuit of scale at the expense of pricing discipline, but perhaps the most difficult challenge to overcome is a secular weakening of demand for power-plant equipment as renewable-energy technologies become cheaper. What's sometimes overlooked is that not all parts of the business are exposed to this latter trend.

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GE's industrial-focused generation-equipment and grid businesses have respectable sales outlooks and their value may be overshadowed by the issues in utility-class electricity generation, Barclays analyst Julian Mitchell wrote in a report earlier this month. This internal break-up could be a first step toward divesting those healthier assets or further isolating the troublesome ones.

I'm actually somewhat encouraged by GE's decision not to give a formal update to its guidance for 2018. To me, this suggests that Mr Culp is planning on finally resetting GE's financial metrics closer to GAAP principles, something Mr Flannery failed to do. Hopefully when Mr Culp updates investors in more detail in early 2019, his outlook will be based on numbers that actually reflect the underlying condition of GE's businesses.

Here's to a good start.