John Flannery, GE’s Chairman and CEO, presented at the Electronic Products Group conference in Florida yesterday, and the market did not like what he had to say. GE’s stock price fell sharply, from the mid-$15 range to the low-$14 range, and picked up downward momentum during the time that Flannery was speaking, around midday.
On the face of it, the presentation contained nothing terribly shocking. Flannery emphasized the company’s newfound focus on cash flow generation, openness throughout the management ranks, and allocating capital to segments on a competitive basis. As any good CEO would, he also underscored the quality of GE’s franchise and its strong positions in aircraft engines and medical equipment, and the bettering outlook for the oil and gas businesses, which has received a big boost from higher oil prices. His focus on simply running the business better — controlling costs, creating visibility into end markets, and getting the day-to-day block and tackling done well — was reassuring.
However, in speaking about the important gas turbine business, slide 4 of the presentation showed a walk from the present 5.6% profit margin to a profit margin of “~10%.” This target margin is lower than that of GE’s Power segment in the past, and we think this discrepancy is what most worried the market.
During the Q&A session, an analyst asked if the 10% margin target represented the best-case margin profile during a secular downturn or if investors should think about that business generating a structurally lower profitability in perpetuity. Flannery left his answer ambiguous, but suggested the former was more likely. Simply the fact that Flannery failed to equivocate that this business had the potential to generate mid-teens margins during the top of the cycle added a pall to the atmosphere, in my opinion.
In addition, the Industrials analyst from JP Morgan, Stephen Tusa, CFA, who had made an accurate call last year regarding GE cutting its dividend, issued a report the day before the conference suggesting that another GE dividend cut was perhaps in store and reiterating his $11 / share price target. Questioners during the Q&A session did not offer their names, so I do not know whether it was Tusa that asked the question or not, but Flannery was asked about the status of the dividend.
Flannery replied using nearly the same language that he did prior to the first dividend cut — “We know how important the dividend is to our investors…” — and that verbiage, combined with Tusa’s warning likely affected investor confidence that GE’s operations are able to support even the lowered dividend payment.
Enough time has passed that I feel better able to view GE through clear eyes. I want to focus my research on the gas turbine market, perhaps valuing GE’s biggest competitor, Siemens, and sharpening my pencil regarding the effect of alternative generation on the future glidepath of gas and coal generation, GE and Alstom’s legacy businesses, respectively.