General Electric Company (GE) Earnings Call Transcript & Summary

Thanks, everyone. Good afternoon. My name is Nigel Coe from Wolfe Research. I'm the firm's multi-industry analyst. And thanks for joining us for the conference. We're getting to the, as you say in baseball, bottom of the ninth innings here on the third day of the conference. Delighted to be welcoming General Electric to the podium. And I'm joined by GE's CFO, Carolina Dybeck Happe. Carolina, thank you very much for being here. It's a pleasure. Carolina, I think you're going to make 5 minutes of opening remarks or so, and then we'll get into Q&A. So Carolina, over to you. Thanks.

Hi, Nigel, and thanks for having me. It's great to be here with you, and I'm still working on learning those baseball terms, but I'm getting there. I'm in the best city in the world for that since I'm in Boston and moving. Well, we're more than halfway through the second quarter, and it's been exciting and busy. We've held our quarterly operating reviews with each of the businesses, and I'm really encouraged by the progress that we're seeing at Power, especially in Gas Power Services. At Renewables, we're very focused on building a profitable growth business, and we continue to see strength in Healthcare. Aviation is still our most challenged market, but we're planning for some recovery in the second half. And I'll speak to Aviation in more detail shortly. But first, I'd like to share some insights on our transformation and our recent leverage actions. Now our journey to become a more focused, simpler and stronger industrial company is accelerating. And with the AerCap-GECAS combination announced in March, we're focusing GE on our core industrial businesses, capturing opportunities presented by the future of flight, precision health and the energy transition. And upon close with AerCap, it will drastically simplify our reporting structure, going from 3 columns to 1-column financials, and it will serve as another catalyst to significantly reduce debt by more than $70 billion over 3 years. And given our stronger financial footing, we've executed additional actions this past week. First, as the next step in our deleveraging plan, we announced a balanced tender of short- and long-duration debt. Due to our strong liquidity position, we acted opportunistically, funding this with cash on hand. And we're continuing to evaluate future deleveraging opportunities, and they are based on economics, deleveraging impact, risk mitigation and optimal capital structure. And today, we also closed on the refinancing of our backup credit facility. And due to our improved liquidity position and lower cash needs, we reduced the size to $10 billion from $15 billion, and we extended the maturity date from 2023 to 2026 at attractive pricing. And overall, we remain committed to achieving a less than 2.5x net debt to EBITDA over the next years, thanks to our finance teams, who continue to be instrumental in making this happen. At the same time, we've been fortifying our foundation, and our lean progress is key. As we scale lean, we're working to improve Safety, Quality, Delivery and Cost, SQDC, in that order, fueling high-quality growth. And lean, coupled with our significant decentralization effort, is enabling this work and maximizing impact where it matters, closest to the customer. Of the businesses I wanted to touch on, now Aviation. So in Aviation, we are seeing some regional differences in the market recovery. So what does that mean today? Well, broadly speaking, GE and CFM departures are up just slightly in May and April versus March. Although some of the positive momentum we saw in April has tapered in May. We're monitoring customer behavior in addition to the vaccine rollout and global border restrictions, both remain uneven. Some additional regional callouts. China is nearly back to '19 levels with rising load factors. APAC, ex China, continues to lag, and this region has the largest proportion of total border closures compared to other regions. and is being impacted by the tragic COVID situation in India. North America, carriers are cautiously optimistic with increasing travel confidence. And some carriers are vocal about adding capacity for the upcoming summer season on domestic routes. Europe significantly lagging down roughly 75% versus '19 levels. We will see what happens. And Latin America is a tougher story in light of the recent rise in COVID cases. And just for context, pre-COVID, more than 60% of the GE and CFM departures were concentrated in North America, Europe and China. So near term, we expect we will be more impacted based on the recovery timing in these regions. And we're monitoring the global trends across our customer base. So stepping back, we're planning for some recovery in the second half. Our Aviation business has the largest and youngest engine platforms. And we have more than 37,000 commercial engines installed, and more than 60% of our fleet has not yet had a second shop visit. And just last week, we announced an agreement with IndiGo to power 310 new aircraft with our CFM LEAP-1A engines. The agreement, one of the largest in CFM's history, includes 620 new installed engines and associated spare engines plus, of course, a multiyear service agreement. Overall, our platform is well positioned to generate value for decades to come. In summary, we had a solid start to the year, and we're set up to deliver on the 2021 commitments we shared with you in March. Across all of our businesses, Services remain a core strength. Despite some near-term pressures, Services orders were up 6% organically in the first quarter, excluding Aviation. And longer term, with half of our revenue in Services, this represents a tremendous growth opportunity. Reflecting on my last year with GE, I'm very happy to be part of the team at this really critical point in our transformation. So thank you for letting me share those thoughts, Nigel, and over to you.

Great. Thanks, Carolina. You mentioned the last year, and you're very happy to be at GE. And I'd be curious, what's changed in that year? And what transformation have you made to the finance function as you go from 3 columns down to 1 column?

Yes. So Nigel, I just -- sort of realizing, when you say the last year, it's actually my first year, right? And I would say that it was probably hard to imagine a more challenging environment to begin as CFO at GE just because of COVID, right? What I would say, though, is that in -- during this year, we've taken a number of important steps. And our efforts to strengthen the balance sheet were obviously paramount, right? And by that, I mean, all the efforts we've put in to reduce the debt. I spoke about the $70 billion reduction but also simplifying our portfolio: BioPharma, [ Healthcare ], Lighting and now the AerCap transition. And beyond balance sheet and portfolio, we're also setting up the company for a strong rebound following the pandemic. And I would say we took advantage of the urgency that was created out of the COVID. Good companies act fast, right? So we acted fast. And with that, we accelerated GE's transformation. And what do I mean by that? Well, it's really about -- well, I would say it includes adopting lean in the way we operate and how we go forward. And that's also supporting our restructuring with sustainable cost-out actions that I have talked about previously. On the organization, how it's changing, I would just start by saying I'm really impressed by the people I've met, and I'm so grateful to have the opportunity to lead this really talented team. And there are many things we do. And I would say in the spirit of lean, we do a lot of things well, but we can do a lot of things even better. And that goes for finance as well. And I would say -- you asked sort of what was -- I'm thinking or how am I shaping the function as well. So I would say, first of all, in finance, we have a strategy to help GE to drive GE's transformation. And part of that is really making sure that we look at the company with a deeper operational visibility and a greater focus on cash. So I would say we're working on getting the right data at the right level and the right frequency to our business leaders so that together, we can drive the right and the most important decisions with speed. So when I looked at that, I said, "Okay, first, right data to be able to take decisions." And we have focused on a more operational, I would say more granular P&L. We've also updated the working capital definition that we've shared with you so that it's better aligned with how we really run the company and how we can drive improvements. The right data is one thing, but also the right frequency, faster, more frequent. We talk about broadly implementing monthly close, weekly collections, and I would call -- say that that's our road to daily management. The third one is on our journey to be a more decentralized company. I'll admit being one of the drivers behind us having almost 30 P&Ls now into this year in our 5 segments, right? So that's also an important enabler to make sure that we have them at all the right levels. And I would say that today, I'm proud to say that every finance employee in GE is working on some of those priorities.

Great. So you talked about taking down the revolving credit facility down to $10 billion. I can't remember what it was 2 years ago, but it was certainly north of $30 billion. Back trends down to -- I think by the end of this quarter, down to about $3 billion. Is that a signal of this improved cash management and consistency of cash flow from the businesses?

Yes. Definitely. The -- when we talk about cash management, we've talked about linearity, right? Because it's about improving the linearity. And we talk about cash management and improving cash linearity, rather reducing the nonlinearity. And what that does is -- and also now going into the fact that we don't do factoring anymore. So basically, you're looking at how do I generate cash on a more linear basis? Which means earlier on in the year and in the quarter. So to do that, I obviously need to collect faster. So how do I do that? Well, I need to improve collections from -- well, much more frequently. And I also need to bill more frequently and earlier on in the quarters, right? So also billing is earlier on in the quarter. And frankly, what we don't talk about is also -- well, we do talk about it, but not quantifying it here is that billing earlier means that you're delivering earlier, right? So it also helps operations and the way that we have a much more smoother profile in how we deliver to our customers. So basically, happier customers, but also better free cash flow profile for us in a much more smooth way.

That's great. So speaking of the linearity of free cash flow, can we talk about maybe second quarter free cash flow? You talked about it being better year-over-year. A low bar because you had a $2 billion cash burn in the prior year quarter. Normally, second quarter is stronger than first quarter. I'm just wondering if there is any kind of context on second quarter and some of the moving pieces you see.

So for the second quarter specifically, I would start by saying, yes, we still expect it to be negative, but we do expect a similar level of improvement as we saw in the first quarter, which we talked about was about $1.7 billion, right? What I also see, though, is that in the second quarter, we will be sequentially pressured by some of the tax payments. We paid tax in the second quarter this year compared to third last year, but also some timing of AD&A. I would also -- I could also see the big reduction of factoring not being 100% smooth even if it's only a timing matter. And if I look at the year-over-year specifics, then if you take the second quarter, obviously, the improvement will be driven by better cash earnings, right? A combination of the cost-out actions as well as the growth that we expect to see, especially in Healthcare. PDx was very hit last year, now it's coming back, so that's going to be positive. And also I expect to see working capital continue to improve. Both continue to improve underlying processes. And then we also have the -- I would say, the specifics of last year where we had a big accounts payable pressure last year which we don't expect to repeat this year. On the other hand, we also have military progress as a positive last year that we don't expect to see this year. And then the last one, I think I mentioned that one was on the AD&A, which I expect to be worse this year. In all, the good [ cost in segments ] that our customers are delivering. And overall, it's good.

Good. And the factoring to work done, I think you've said that bulk of that will be done in this quarter. Is that still on track to be done by the end of this quarter?

Yes.

Okay. So no confusion around free cash flow in the back half of the year, should be very clean. What you see is what you get basically. Okay. Good.

Yes.

Any additional comments on the second half free cash flow coming? Or should we just move on to longer-term free cash flow?

On the second half -- well, again, we continue -- well, we expect continued improvements in earnings and working capital. There are a couple of specifics, though, that basically second half last year that I would like to call out in that case. And that -- remember, we talked about the Boeing 737 MAX payments, it's about $0.5 billion headwind. And we also had -- end of last year, we also had significant progress payments from large bulk in Renewables orders that we know are lumpy by nature. And then there was -- there's also a smaller impact from the deferred payroll taxes with the CARES Act that we don't see this year.

Okay. Great. So the high single-digit margin, $7 billion or so of free cash flow, your targets. Maybe talk about some of the major movement pieces behind that. What do you see as the major driving forces outside of earnings to get to that level of free cash flow? And maybe talk about how you see the businesses within that mix.

Yes. Sure. Yes. We've talked about the high single-digit margins, right? And we've talked about 2023 plus, which basically would imply a $7 billion-plus free cash flow on base of '19 sales. I would say though, you talked about what's outside of earnings, but the growth will come primarily from earnings, right? And I see that as being sort of critical to enforce that it's really based on healthy organic growth, focuses on Services mix, continued operational improvement. And then lean on the work we're doing will help offset sort of the natural working capital needs that we will have with growth. And then on top of that, we also expect to spend significantly less on restructuring, legal and pension. And that's up to a couple of billion compared to 2020. You asked about it per business. So why don't I take it business by business then. So starting with Aviation. John -- and we have talked about that we expect the commercial markets to recover to '19 levels, right, and that we continue to work on the cost-out and that we expect to see high single-digit revenue growth in the military, I would say despite this year's challenges. This would then translate to free cash flow also at the levels that we saw in '19. And so basically, more than $4 billion, and we can see a sort of a conversion rate of more than 90%. We've also talked about that cash will recover faster than op profit. I would say partly because of -- sort of as we continue to have the portfolio transition with the introduction of new engines, we get sort of a negative mix. And then over time, we expect the margins to return to high teens, and that would basically give you an op profit of more than $6 billion from Aviation. In Healthcare, it's very much about growth, right? So here, it's about continuing to invest in the profitable growth. And we talk about new, exciting products, right? And on balance with that, we, of course, continue with lean here as well. So we continue to take cost-out, but also to improve working capital. And here, we're planning for continued low- to mid-single-digit revenue growth and the annual 25 to 75 bps of margin expansion. And I would say the normalized cash flow conversion here would be around 100%. So this -- basically, this would get you to, say, $3 billion to $4 billion of op profit. Power, yes. Well, we expect to see the continued improvement in Gas and really driven by the Services growth and the cost-out. And we've also talked about that we are very focused on equipment underwriting -- or improving our equipment underwriting, which basically means less turnkey scope, but a better risk-return equation over time. And we are on plan to achieve high single-digit margin this year in Gas Power. And we also talked about that we would expect this to be maybe 90% free cash flow conversion by 2022. The smaller businesses in Power. So we're completing the restructuring of the exit of the new coal -- the new build coal and steam, right? And I would say that the combination of Steam Power conversion and Nuclear, we expect to be both profitable and generating cash in 2023. And then Renewables. So again, here, we expect a profitable growth in onshore wind, both through Services growth and cost-outs. And as we start to see revenue growth from Haliade-X, revenue and bottom line, right, in offshore wind, that's also going to drive margin expansion and cash. And then we have our turnaround upgrade which continues. And so I would say, overall, for Renewables, we expect the business to have a positive free cash flow this year and to be breakeven by 2022, which is next year, right? Finally, moving to these dimensions of corporate, continue to improve and to reduce costs as we move on our decentralization journey. Now I will add -- this was sort of the businesses, but I would also add that going forward, of course, I've talked about working capital and working capital improvement, but also efficient capital deployment is key across the businesses. If you aggregate all of that, you basically get to our high single-digit free cash flow margin target. And overall cash conversion, 85%, 90%, right?

Okay. Perfect. So it looks like you're targeting $4 billion of Aviation free cash flow, about $3 billion for Healthcare. I'd say about $1 billion or so for Power and Renewables as a bucket and perhaps $1 billion of outflow corporates, other items. Is that a sort of fair framework?

So I gave my details and you did the math on that, so I think we're good.

Okay. All right. Yes, my math is not always 100%, so a little bit like your free cash flow conversion. So on pension, I did want to touch on pension because you mentioned that the bridge to the leverage targets, and pension is basically all of your leverage at this point or pro forma leverage. The rating agencies are using the $20 billion year-end number, year-end $20 billion number. Can you just -- maybe just bring us up to speed in terms of where we are at current discount rates, current market returns on that $20 billion today?

Well, actually, I really appreciate the question. And I would also say that pension -- so it's a topic, and it's not always well understood. Maybe some background to us and our pension. So we've worked really hard to derisk the pension profile, right? And that really comes down to 4 areas that we talk about. So you have the design of the plans, you have the investments, you also have the funding and the settlement. You start with the design. A couple of big important parts that have happened. So first of all, in '19, we announced that we would freeze the U.S. plan for salaried and reduce the benefit for the execs. Basically, that reduced the deficit by $1 billion and reduced the annual service costs. And we expect that the service cost is down to about half of what it was and basically $500 million in 2021. And we've also talked about that we're also working on freezing our U.K. pension plan, but -- and that's still work in progress. So design is one -- important one. The other one is really on investments. And I would say here, we really continue to actively manage the investment portfolio. And we've had 2 years of strong returns, 18% each. And we also realigned, you can say, the fixed income portfolio with the hedge portfolio. So today, about half of the risk we have is -- half of the risk that we have in interest is hedged. On the funding side, well, if I look at 2018, we -- well, we put in $6 billion, right? At the end of last year, we put in $2.5 billion. So $8.5 billion prefunding. And then if I look at sort of where we are, so the U.S. plan has about $10 billion of deficit. And we don't expect -- as we talked about, we don't expect any funding through the end of the decade. And it's really a combination of the asset returns, the prefunding, but also the American Rescue Plan Act. And then I would say we also have the other part, which is the pay-as-you-go plans. It's about -- well, it's the other $10 billion of deficits. And here, we expect to see sort of stable payments of $0.5 billion per year, which is included in our free cash flow. And I think what's interesting is when we talk about this -- well, we call it PAYG plans. I'm going to leave the valuation to you and others to do. But the way to look at it is that you either include it in the free cash flow as we do or you view it as liability, but not both, because I have seen there's been some confusion in that. Decide which one, but it's not both. And finally, on settlements. I've gotten questions about, so what are you doing on settlements? What are the opportunities there? And I would say, "We do look at opportunities. We have a, maybe, opportunistic view." And I would say that they need to sort of both -- fit both criteria or reduce deficit but also be economically viable, right? So as long as that's balanced, then we don't change it. So we do that. I'm not going to mark the pension here now, but you're right. So clearly, we're benefiting from higher rates, net of the hedging impact that I talked to you about. And by the end of the year, basically, the market will include both the impacts and the asset returns. And on the sensitivity, it still stands. So basically, we've talked about that for every 25 bps, it's $2.4 billion of impact, but half of that is hedged. So I would say the 25 bps basically are equivalent to a little bit above $1 billion of impact.

Okay. There's a lot in there -- coming there. So just...

A lot to mention.

So you mentioned that you've got funding relief on the principal plan. So no funding envisaged for the foreseeable future there. And on the pay-as-you-go, I think more than half of your liability is pay-as-you-go. And there's no funding requirements there. You're already funding those progressively, so there's no funding to call there. So it feels like your pension kind of -- sort of cash claims here are very well defined, is that fair?

Absolutely. And we're in a much better place compared to where we've been historically. So really happy about that. I'm really happy about sharing the news that no funding needed for just the decade.

Great. Fantastic. In your prepared remarks, you talked about Aviation margins, $6 billion of op profit, high-teens margins. As we sort of ramp up the curve with, obviously Airbus talking about getting to potentially 60, 75 build rates per month. As that OE increases, what are sort of the R&D fund requirements? And what sort of OE sort of like pressure might we see the margins as we come back at that curve. Anything to call out there?

I would just maybe start by saying that we expect to get back to '19 departures, but we've talked about narrowbodies in '23, widebodies in '24, right? And we've talked about the shop visit, for example, we don't expect them really to be back to peak until beyond 2023. We are confident, though, that we'll get back to 2019 levels, right? And then that's both revenue margin and cash. How we get there will depend -- or how fast we get there will depend on the market recovery and the impact it has on us. I would start by saying that the shop visit revenue recurring to '19 by 2023, fine. And then the margins, where we talked about returning to the historical high teens, and that is including also the cost actions that we did. If you talk about the R&D and the new -- the platforms, I talked about that in my introductory remarks. So yes, OE will be a headwind as we go through sort of the portfolio transition. But I would say as -- usually as volume ramps, some of the temporary cost-out measures will come back and we will have the restructuring savings there, but you also need to look at that mix on the new platforms. Money-wise for R&D, I would say, as a percentage of sales, we accepted -- well, we expect it to sort of continue to be on the 7% to 8%. That is both internal and external funding. And I would say, overall, we do expect also that the third-party funding will sort of continue to increase over time. But how exactly will depend on how this plays out, right?

Fantastic. And then you mentioned Power Services, and that's been a perennial sort of problem child since -- for the last 3 years. It's been flat to negative for most that time. But maybe just to clarify your comments on what you're seeing right now in Power Services and maybe talk about transactional CSAs and upgrade activity.

Yes. So on Power margins, I would just start by saying we are still tracking towards the high single-digit margin for Gas Power. And key to this is clearly the Services part, right? We expect to see low single-digit Services revenue growth this year, which is the higher margins, better mix, very much Service-focused here. I would also say that we continue to see improvement. Well, we talked about different types of Services as well, right? So you have the contractual and you have the transactional, right? So we expect to see good results on both. We also talked about transactional having a good, I would say, backlog coming into the year. So we do expect that to be a big part of how we get Gas to high single-digit margins this year.

And Power Services is still your highest margin revenue stream in Power. I mean -- I think we used to think of this a 20% type margin business. Is that still sort of a decent number?

It's definitely the highest margin part of Power margins, yes.

Okay. We're running a bit short on time, Carolina, but there is a question or 2 from the audience, if I can just throw those in. I want to hear what's been done to ensure negative news makes its way up the chain of senior management unlike the past.

I would say that something that's very sort of near and dear to my heart and also as a company, sort of embracing reality and making sure that we have transparency and candor. And I think it's important how you treat people who come sort of with bad news. And I think the critical thing here is really that it's not about the news, it's about what are you going to do about it? That's the important part. And I think that people see that and they trust us and they trust the system that it's really about what are you doing to fix things and not sort of what is the issue at hand. It's about what are you doing to improve it and focus on continuous improvement. And in that environment -- it's a bit of a different environment where people then share and they work on improving. And together, we move forward.

Great. And then just one more clarification on factoring. The second quarter, I think you talked about $5 billion of factoring reduction. Is that primarily going to hit in 2Q? Or is it 2Q and the second half of the year?

So what we have said is that a majority of the $3.5 billion to $4 billion that is going to be part of our discontinued factoring will be felt in 2Q.

Great. That's perfectly clear. Well, Carolina, I can't believe half an hour has already passed by. So thank you so much for your time. It's been a pleasure to host you for Q&A. And good luck and speak to you soon.

Absolutely. Thank you for having me.

Thanks, Carolina.

Bye.