General Electric Company (GE) Earnings Call Transcript & Summary

Good afternoon and thanks for joining us for day 2 at Morgan Stanley Laguna Conference. I'm Josh Pokrzywinski, the firm's U.S. multi-industry analyst. Joining me for this next fireside from General Electric is Chairman and CEO Larry Culp. Before we get started, I need to read some disclosures. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Larry, thanks for joining us. Always a pleasure, especially in this virtual environment. No sun, no sand this year, but glad to have you all the same.

Josh, thanks. It's good to be with you. We'll hopefully be together next year in Laguna, but we're hard by Fort Point Channel here in Boston this afternoon and appreciate the opportunity. It has been a busy third quarter thus far at GE. It's hard to believe it's only been 7 weeks since we were together at earnings. We've kicked off our strategic plan reviews with each of the businesses. We started off with our digital business 2 weeks ago. We're midway through this afternoon, the reviews with our Aviation business. We had the entire team together, albeit virtually, last week, the entire GE global team, 200 leaders from around the world for our senior leadership meeting, really good opportunity for us to come together and just make sure we know how we want to finish out this year and also get ready for 2021. If I may -- I know we want to get into Q&A, but if I can maybe just give you a couple of quick thoughts on what we're seeing and how we're looking forward here, particularly as, if you can believe it, I'm but 2 weeks away from 2 years in saddle here. The last 6 months, clearly, life for everyone has felt far longer. But I think as I sit here today, feeling very confident about where we are and where we're going despite all of the trials and tribulations that COVID has certainly thrown at us. As I reflect on just where we are here in the quarter, I think we came out of, clearly, the second quarter, the toughest quarter, I think we're going to see, hopefully, again in our careers, if not our lives, very focused as a team on that, which matters most, safety, taking care of our customers and driving cash flow. Good progress on the $2 billion cost out, $3 billion cash action work plan we've talked about repeatedly here over the course of the summer. I think you're going to see that play into the second quarter -- or excuse me, the second half results. Really good set of presentations at the senior leadership meeting, Josh, last week. A little bit of inside baseball, admittedly, but just we put a real focus on lean and how lean is being deployed to drive safety improvements, quality, delivery and cost, both in terms of productivity but also working capital and CapEx reductions. So you can see that flywheel beginning to turn in earnest at GE. I think we take a lot of confidence from that. Clearly, our markets are, by and large, stabilizing, but not in any way rapidly recovering. But we're not going to wait on the markets. That's why we're taking the actions that we are. You put all that together, I think net-net, we're of the view that today -- we're of the view that we will deliver positive free cash flow here in the back half. That's a good sign. Will get us out of this year going into next year, I think, with strength. But I'd just do a quick runaround. The businesses clearly at Aviation, we got hit hardest there. That's where the bulk of the cost and cash actions are underway. We talked at earnings, I think, about our departure data, something we look at on a daily basis, down 47% back 7 weeks ago. We're at 40% year-on year now. So still way down, but a little bit of sequential improvement. But admittedly, it's gone a little bit sideways. You see that in some of the other high-frequency data around the industry. Interestingly, China is a standout. China is just about back to where it was pre-COVID, but I think we're seeing Europe and the Americas deal with the outbreak of cases as you well know. But I think we're optimistic that we're doing what we can with what is within our control and we'll come out of the COVID moment with the largest, the youngest fleet in the business. If I go to Healthcare, the other business that got hit here, we're very pleased with the recovery and scan activity. That has clearly come back and turned. Our pharmaceutical diagnostics order book has nearly recovered, probably down now low single digits compared to the high single digits just a few months ago. So a little bit of room to run there. That team has done a phenomenal job with respect to margins. A little bit of volume in PDx will help. But again, we're not going to bank on a robust market recovery. We're going to have to make our own luck. Pre-COVID, we knew this year was about the turnarounds, right? Continuing to turn around at Power, picking up the pace at Renewables. Fortunately, those businesses haven't really been hit hard here in 2020 from COVID. Their progress continues. And I think we're looking for both of them to continue to pursue their restructuring work here in the back half. And I mentioned we kicked off the strat plan 2 weeks ago with our digital business. We don't talk a lot about it. I think we'll talk more about it in 2021, but that's $1 billion P&L that sits within our corporate bucket. A good business, tremendous improvement the last 12 months. I think we're going to be able to talk about growth, margins in cash there before too long in addition to the impact those businesses are having on the rest of the GE portfolio with respect to our digital transition. So if you think about where we're going long term, right, return to flight, precision health, the energy transition, I think the team that was together last week is ready to go, lots of momentum with respect to lean. Clearly, our technology continues to lead. Big news here recently out of Taiwan, another big H win as we help that country on its energy transition plan, Haliade-X in Renewables, clearly, the 9X and Aviation, just a lot of good long-term bets continuing to bear fruit. And that all, of course, helps complement that nearly $400 billion backlog that we have. It keeps us close on a daily basis to our customers. So a lot of work to do, still, Josh, but I'd say as we get ready for the fall here, I think we're feeling good that despite the uncertainties and there certainly are plenty of uncertainties out there still, the GE team is aligned and making progress on those things that we think are most important for our customers and for our shareholders.

That's an excellent update and a good starting point, Larry. I appreciate that. I guess first, follow-up to that on the free cash flow side. Positive in the second half. Clearly, good momentum there. And I wouldn't say the market is doing you any massive favors, especially in aviation, to support that. If I had to think about seasonality, clearly, fourth quarter last year was a big quarter within that and a big driver of last year's free cash flow success. Fair if I think about it similarly this year that you will see kind of a bit unevenness in 3Q and more in 4Q to support that?

Yes. No, I think that we're putting a lot of energy into trying to drive greater linearity, both within a quarter and throughout the year in a whole host of areas. But no doubt that you're going to see the positive second half be carried here by, I think, a robust finish. We know that working capital has been a little bit more of a drag for us than it should be. I think you'll see that sequentially improve as we work through the rest of the year. Clearly, the cost and cash actions I referenced earlier are also similarly back-loaded. And I think we're making good progress, just dampening down the CapEx across the company. Clearly, we want to continue to invest in technology. But given the circumstances, we can hold some things, we can cut the scope on certain projects. So you put all that together, I think that's really the view that we have as we finish this year and get it ready for what we think will be a positive free cash flow in '21.

Got it. So that's helpful. And yes, that was going to be my next follow-up, on 2021. Obviously, if we're speaking in engineering terms, the bridge into 2021 on free cash would be pretty exotic, we'll say. A lot of moving parts, especially with working capital and aviation markets. But maybe within that return to full year positivity, is there something that people need to keep in mind as maybe a starting point on, hey, we need to assume that departures get to a certain level or some of the other businesses normalize. Obviously, way too early for guidance, but maybe a framework for how you guys have internalized that path to positive.

Sure, sure. Yes. And I don't want to try to give you anything resembling guidance. But I think the construct, Josh, that we have in mind as we think about '21 being positive, that ultimately a way point toward high single-digit free cash yields on the business as a whole, really starts with just running the business better. We've talked a lot about lean, but whether it's the commercial front end and just being better around increasing our visibility around new business, let alone our win rates, as we chase new business, being smart about price terms, all of that, that's a gradual effort that we think we see in some of our activity, our order books today, more of that as we go into '21. Certainly, operationally, talk a bit about lean. I won't repeat that, but that continues to build momentum. And all of that comes on top of, if you will, a little bit more muscular work that we did this year in wringing out $2 billion of cost. That's probably $1.5 billion to $2 billion of structural effect, let alone the cash actions. And don't forget, we talk about these inheritance taxes, right? Some of these cash calls from days past, that was $4 billion of outflow last year. That will be half that level next year. So we'll have another nice step down in '21. So you put all that together, we're not really waiting for the markets to come back and put the win we had in our sales even early this year. We know this is going to be a self-help story for a little bit longer, particularly given the aviation dynamic. But I think that's how we get there. And of course, at this point, there's probably $500 million of pension in '21 baked into that positive construct for next year.

Got it. That's helpful. That was going to be some -- one of my other questions in terms of some of the bridge items. And just to be clear, on inheritance taxes, I was going to save it for later but might as well keep the thread going. From the $4 billion to the $2 billion last year versus next year, where are we this year? What's the delta '20 to '21 in your mind?

If we're going to $2 billion next year, assume the step down is more or less equal -- equally split between '19 to '20, '20 to '21.

Got it. Yes, that was a fair assumption, but 2020 has been kind of a weird year, as you may have noticed.

And it's not over, Josh. But Josh, just one quick thing. I just want you to be clear. I want to be clear with you. When we talk about inheritance taxes in a session like that, I think it's important for investors to understand how to think about cash, what we're working on, what really will be a function of time by and large. But operationally, when it's just us on the inside, we don't spend a lot of time talking about inheritance taxes. They are what they are. They've been coming down very much as anticipated. We focus on those things that are within our control, not those things that we just have to wait out.

Understood. Understood. No, I think that's a valid point. On the Aviation business specifically, I guess, now with a bit more time since the depths of the downturn and some modest improvement off of the bottom, ideally, customers are kind of picking up the phone and expressing themselves versus saying, "Oh God, we don't know. Don't bother us." I guess what have you learned so far about the industry, customer behavior, anything on cancellations, retirements, rotation of fleet, kind of all the elements that go into the stew that need to get sorted out over the next, I don't know, 18 months.

Right. Well, rest assured, Josh, we are in daily conversation with a lot of customers all around the world, both at Aviation and GECAS as we -- really as an industry, try to work through this unprecedented challenge. Yes, what have we learned? I'm not sure how much of what we have seen is new learning versus, if you will, affirmation of certain things. We knew to be true about our customers and our industry. I've been impressed as a relative newcomer how, even at these critical junctures, the industry is so hyper-focused on safety, right? And some of that comes in the wake of what happened with the 737 MAX. But even with COVID, I think you see the industry coming together increasingly with common themes, if not a common voice around how we assure the flying public that it is safe to be in a -- in an airplane. I think we see not only the experience that a number of aviation leaders have from prior crises but just the sharp operating skills as they try to navigate the near-term pressures, right? Various customers have varying degrees of balance sheet strength. Everyone's trying to work through that smartly, not only with lenders but also with suppliers like us. We see that, obviously, both on the OE side and on the aftermarket side of the business. So it's not pleasant, right? A lot of pressures, a lot of uncertainties out there. We're certainly getting impacted in our biggest, most profitable business. But that said, it's really just, I think, more of an affirmation that we work with some outstanding customers all around the world, and we're doing all we can to help them navigate the uncertainty and the challenge that this pandemic has thrown at us.

That's fair. And I think we're all trying to solve one particular equation on the aviation side is, if I told you there was a vaccine tomorrow, what do you think that means in terms of returning to something normal on aftermarket activity? And there's a whole bunch of assumptions in that in terms of time and pricing and what our actual shop -- what's the actual shop capacity when everyone comes in. But is there something that -- oh, great, the lights are going to go out in here because I don't move enough. Is there a common set of assumptions you guys are making in terms of that relationship between when activity can start vis-à-vis a vaccine and when you might actually see it show up in the business?

Well, I would say a few things, Josh. One, having sat on the Board of a large global pharmaceutical company for nearly a decade, I'm acutely aware that going into Phase III doesn't mean you're coming out of Phase III successfully. That said, 2 of the clinicians I've been in communication with the most, the 2 clinicians I trust the most on this call relative, are we getting close to a vaccine, their tone in the last 6 weeks has been, I think, far more optimistic than it was back in the springtime. So I take some solace in that, that a vaccine is coming. But whether it's a vaccine or just the return of animal spirits, frankly, I'm of the view that people want to get back to it, right? I know how exhilarating it's been -- for those of us back in the Boston office here, to be back at in a more normal fashion. So I think we're going to see that play out in the months to come. But in terms of our business, we're not going to bank on a vaccine at this date or that date or really any of the other macro factors that are very much outside of our control. We're just trying to make sure we're doing all we can to stay close to customers, help on the safety front where we can, help them work through, whether it be a reconfiguration of their skyline, right, on the OE side of things, let alone what we can do in the aftermarket. As you can imagine, with 38,000 engines in our installed base that we support, we've got a critical role in the short term and longer term to help our customers navigate COVID, not only as they try to conserve cash in the short term but to make sure that as we put these planes back up in the air that they are safe, efficient and fit for purpose.

Has there been any revelation or updated thinking on your relationship and the aftermarket relationship to when flight happens as -- again, it's still early, but whatever view you had 3 months ago, is that still where you're at today just because we don't know any better?

Well, I think we're clearly closer to that point, just with the passage of time. Josh, I think you've seen us try to avoid saying we're going to be back at this date or that date for certain. I think there are just too many unknowns at this point. But clearly, given the departure trends broadly, given what we've seen in China, perhaps the vaccine data and just the restlessness that I think you see out there in so many places, this industry will recover. There's no doubt in my mind about that. It's really a function of time. We know it's going to take a while. It's not going to be next year. It will be a little while here. And again, I think we just want to make sure we're smart about how we run our business, both with the short and the long term in mind, so that we're doing the best we can during this period of stress, but also, we make sure that when -- if you will, the cloud is clear, that GE Aviation continues to lead this industry and to be a stellar performer, both for our customers and for our shareholders.

Got it. I appreciate that. And when those clouds do clear, are there any actions that you've taken today or this year that end up being kind of initial offsets to that improvement?