According to the Wall Street Journal, GE’s LEAP engine accounts for $4.8 billion of GE’s roughly $7 billion in industrial profits. This engine is Boeing’s only configuration for the 737 MAX, but it is also used in the Airbus A320neo airliner. GE does not break out the orders between Airbus and Boeing for this engine.
However, we can reliably assume that the Boeing cancellation will do significant damage to GE’s cash flow for a couple of reasons.
First of all, aviation accounts for over 60% of GE’s industrial profits. Second, the 737 MAX grounding has already done significant damage to General Electric’s free cash flow. The Wall Street Journal says that it cost them $400 million per quarter in the past three quarters.
GE’s outgoing CFO, Jamie Miller, said in the third-quarter conference call that working capital changes, a component of free cash flow, was negative $1.8 billion. A big portion of that was due to the “timing of collections from Boeing related to the 737 MAX program.”
Boeing had slowed down the production of the 737 MAX. And this cost GE $1.8 billion in one quarter alone. But now it is not a matter of “timing” of payments. There will simply be no more payments.
Recent Analysts Downgrade on GE Stock Price
In fact, one analyst, Stephen Tusa at JP Morgan, recently wrote a scathing report on GE about its finances. He says in his report that even if Boeing starts up production, General Electric won’t benefit.
GE has already received billions in advances on 737 MAX production payments. Even if production started up again, there would be a significant lag effect. New payments would significantly lag the outgoing costs of new production.
Moreover, Tusa estimates that Boeing accounts for over 70% of its aviation unit’s profits. And, as the WSJ pointed out, this unit accounts for over 60% of industrial profits. Needless to say, Tusa has a “Sell” rating on GE stock and a $5.00 per share target price. That is a drop of almost 55% from today’s GE stock price.
One analyst believes the production halt will actually be positive. He believes that the production of LEAP engines for Boeing produces losses for GE. There is no way to verify this statement. All indications are that this complete production half will be devasting for GE.
For example, earlier this year Boeing cut 737 MAX production to 42 airplanes from 52 per month. This hit of 10 planes month caused a loss at GE of $400 million per quarter, according to the WSJ. So an additional cut of 42 planes per month will like cause over four times that amount or $1.6 billion per quarter.
Moreover, based on the CFO’s statements in the conference call, the cash flow effect could be even larger. Possibly over three times that amount, since production advances will no longer flow in.
GE’s Cash Flow Problem
In short, GE is trying to sell more LEAP engines to Airbus. According to that same WSJ report, GE’s share of the A302neo airliner engine production would rise. This plane is the Airbus alternative to the 737 MAX.
GE previously had built 50% of the production line engines, along with Pratt & Whitney, a unit of United Technologies (NYSE:UTX). Now GE is going to produce 58% of the engines.
General Electric has to more along these lines. It has over $87 billion in debt, which costs GE over $2.6 in interest per year. Recently GE has sold a number of large assets, up to $38 billion, which will lower the net debt to $49 billion.
If cash flow losses start to dramatically hit its bottom line, GE may have to borrow more money, sell more assets, or a combination of both. Moreover, its credit rating could deteriorate. That would raise GE’s interest costs and lower cash flow.
What Guidance Is There For GE Stock?
There is no silver lining in the Boeing 737 MAX production halt for GE stock. It will severely future cash flows. It is not easy to predict by how much. That may be one reason why GE stock has not fallen a lot yet.
For example, one analyst complained to the WSJ that GE discloses “insufficient information to model any of this.” That is not good. An analyst who closely follows General Electric cannot model out the cash flow hit to GE stock.
I complained about a similar issue on GE’s disclosure in a previous article. Maybe the new CFO who starts in January can help explain things better for the public and analysts.
The Bottom Line on GE Stock
Meanwhile, GE’s third-quarter report increased guidance for 2019. The slide presentation shows projected “adjusted” earnings per share of 55 to 65 cents per share. That puts GE stock on a price-to-earnings ratio of over 18 times earnings. That is a fairly high ratio.
In addition, GE said FCF would be between $0 and $2 billion for 2019. Assuming $1 billion in FCF, GE’s FCF yield will be a little over 1%, given its $96.3 billion market value.
Both of these valuations are way too high for a “turnaround” company facing a huge dent in its free cash flow. So far GE has not said how much the production halt will affect its finances.
I would expect the worst. Be careful with this “turnaround.” You will likely have a chance to buy GE much cheaper in the future, at least until the Boeing situation turns around.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks, which includes both dividend and buyback yields. In addition, subscribers a two-week free trial.