The timing of the optimistic comments from General Electric (NYSE:GE) CEO Larry Culp was anything but a coincidence. Just one trading day after GE stock fell another 6% in response to an alarming assessment from JPMorgan Chase analyst Stephen Tusa, Culp appeared on CNBC’s “Squawk on the Street” to ease some of the concerns Tusa raised.
It didn’t work. The GE stock price was off another 4% on Monday despite the pep-talk earlier that day.
Why? The market has to get some of the blame. It was a poor performer on Friday and again on Monday. General Electric led the bearish charge both days though, mostly because Tusa’s thesis held water. Culp’s confidence didn’t.
What They Said
It’s not a story that needs much in the way of explanation. GE, once an icon of American industrialism, is in shambles.
After years of misguided leadership under Jeff Immelt, that CEO stepped down in October of last year to be replaced by John Flannery.
A little more than a year later, Flannery also stepped down to be replaced by former Danaher (NYSE:DHR) chief Larry Culp. The revolving door in the corner office is only a symptom of the organization’s lurking challenges.
Analysts, already skeptical that any leader could meaningfully salvage the company, are suggesting things will get worse for General Electric before they get better, if they get better at all.
JPMorgan’s Stephen Tusa is arguably the ringleader of those doubters. Tusa lowered the firm’s price target on GE stock from $10 to $6 on Friday. In his critique he cautioned that on their current trajectories, six of the company’s remaining eight divisions will produce zero cash glow by 2020. Tusa writes:
“Some sell-side bulls now point to “liquidity concerns” as the driver of share price weakness, though this misconstrues the Real Bear Case (RBC) – namely $100 billion in liabilities and zero enterprise free cash flow even after a 95% dividend cut. While the stock is down ~70% from the peak of $30, this move still does not sufficiently reflect the fundamental facts, in our view.”
Culp quickly countered, explaining to CNBC’s David Faber on Monday that General Electric “is a fundamentally strong company with a sound liquidity position.” He added, “We are taking aggressive action to strengthen our balance sheet through accelerated deleveraging and position our businesses for success.”
At first blush, it’s a response that serves up all the requisite optimism a CEO of a turnaround story must display.
Take a second, more careful read of Culp’s defense, however, and Culp may have inadvertently, indirectly bolstered Tusa’s case.
Reality Check
Culp clarified that GE is sound in terms of liquidity, but Tusa didn’t disagree. Though other analysts have voiced concerns of liquidity, Tusa has (now) repeatedly said there are bigger issues at hand. Namely, the bulk of General Electric’s business lines are running into headwinds that so far are insurmountable.
End result? Less and less profit, and less and less cash flow. Last quarter’s $1.1 billion in industrial free cash flow will leave the company short of its full-year cash flow target of $6 billion.
For perspective, back in 2014 before every aspect of the company came unglued, GE produced $27 billion in operating cash flow and more than $20 billion in free cash flow.
The company has shed some business lines in the meantime, but even adjusting for divestitures, GE’s cash flow tallies remain miles away from where they should be.
The company seemingly intends to keep shedding assets too, with Culp outright conceding to Faber “there is a sense of urgency for us when it comes to asset sales” as a means of dialing back leverage.
In so doing, however, General Electric is also culling its capacity to drive much-needed revenue that can be turned into net earnings and positive cash flow.
That sort of short-term fix isn’t necessarily the best long-term solution. Just ask owners of Sears Holdings (OTCMKTS:SHLDQ), who watched the retailer sell its best revenue-bearing, productively-profitable assets to keep the company afloat while it failed to fix what was broken.
Bottom Line for GE Stock
Whether followers of GE stock realize it or not, it’s a binary matter that’s been debated for months. Should the company earn its way out of trouble, or should it sell its way out of trouble? Which is more plausible?
Ideally, it would always be the former, but that’s not the path General Electric seems to be on.
Any revenue-bearing asset that is sold to another player is bought because the buyer believes it can do more with that asset than its previous owner could.
That is to say, the reason Westinghouse Air Brake Technologies (NYSE:WAB) was willing to acquire GE Transportation for $11 billion earlier this year was simply because it felt confident it could achieve a decent ROI. GE felt it would be able to generate a better ROI with the cash… at least right now.
One of the companies will be right, and one will be at least a little wrong. Whatever the case, GE no longer even has the option of extracting more value and more cash flow from its now-former transportation arm.
There’s also the argument that General Electric is such a complicated hodgepodge of divisions, its transportation business truly was a distraction. Maybe.
Whatever the case, Tusa appears to be more right about General Electric and the future of GE stock than not. His final assessment hits the bigger-picture nail right on the head:
“While liquidity is certainly debatable, we believe this is not really about liquidity, it’s about a deterioration in run rate fundamentals.”
At some point, GE has to start selling more goods to more customers at higher prices.
Don’t let the liquidity debate distract you from the bigger hurdle ahead.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
