General Electric Needs to Diversify In Order to Stay Relevant

As travel continues to decline, General Electric needs to look beyond its aviation division to generate profits

In early March it became abundantly clear that the novel coronavirus was no longer a hoax and sent the economy into a free fall. General Electric (NYSE:GE) faced the brunt of this fallout, with GE stock declining 45% since the start of the year.

This Is Why GE Stock Needs to Diversify to Stay Relevant
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With the aviation industry in turmoil, the spillover effects were felt by General Electric’s airline production sector, leaving many to question the future of the industrial conglomerate. While the optics may not look too good for the company at the moment, it is still worth the investment in the long-term.

Travel Decline Impacts GE Stock

Prior to the pandemic, General Electric was well-positioned to gain from a prosperous financial year. The company had big plans to increase its current earnings and free cash flow (FCF) — both now remain a distant dream.

On Thursday, May 11, GE stock saw a 3.2% decline in its price as the company’s CEO, Larry Culp, spoke on the financial position of the company. While the speech did not include any surprises, it did confirm people’s sentiments on the increasingly negative impact that the travel industry has on the company’s bottom line.

The premise of Culp’s speech covered a number of hurdles and opportunities for General Electric. The aviation industry was upended by the coronavirus pandemic, but recent developments in the Covid-19 vaccine have changed the course of the sector’s downward trajectory.

Updates on a potential vaccine for the virus meant that we were one step closer to a cure and improved the public perception of the future of travel. This is reflected in the price of GE stock, which is currently at $7.88, slowly escaping its 52-week low of $5.79. The resurgence of airline travel is good news for General Electric, which is a big player in this sector.

The Airline Division Hits New Lows

General Electric was set to make some big moves in its aviation business in 2020 to make up for unprofitable segments like power and renewable resources. The company is one of the largest manufacturers of jet engines that are financed by GE Capital Aviation Services (GECAS). Despite seeing little to no activity in the travel space, General Electric’s CEO remains positive on the company’s long-term prospects. He believes in the durability of its leased aircraft and things the company can overcome the adverse effects of the pandemic.

According to Culp, “85% of the fleet [is] regarded as Tier 1, Tier 2, [it’s a] much better fleet, a more diverse fleet than we had during the great financial crisis.”

But given the CEO’s surreal optimism, it may take a while for the company to see a measurable impact on its finances from the GECAS arm. Market analysts predict it will take years before the travel industry goes back to the way it was in 2019.

The price of GE stock is mostly driven by commercial aviation, which took a major hit since the dawn of the pandemic. This affected the company’s aftermarket valuations. The first-quarter saw a decline in the use of their commercial fleet, which led to a lower number of contracts and forced the company to do a write-off in Q1.

Given the current state of affairs, it is quite possible that the losses will be carried forward to Q2 as well. The lower revenues will have a direct impact on the company’s FCF, which is estimated to be between negative $3.5 billion and $4.5 billion in Q2. This is a stark contrast to the original prediction of negative $2.7 billion FCF.

Time for Other Business Divisions to Step Up

As the aviation unit continues to crumble, investors may be quick to sell the GE stock. However, all hope is not lost, as the company can use this opportunity to leverage its other business units like healthcare and renewable energy. The current FCF of both units is $1.2 billion and -$1 billion, respectively, but there is still room for a lot of growth.

In the healthcare space, the company has a global brand name, but it needs to diversify its portfolio through acquisitions for a stronger market position. GE will need to raise additional capital to boost growth while keeping expenses low across operations to generate high returns from this business unit.

In 2019, General Electric made some big moves in the wind energy space with its Haliade -X 12 wind turbine. The technology is expected to cast a shadow over traditional wind turbines and power millions of homes. As aviation takes the backseat, the company’s renewable energy is ripe for development. Only time will tell if its big bets in this space will pay off.

The Bottom Line on General Electric

General Electric’s FCF will undoubtedly fall in the upcoming months given the drastic reduction in revenues from its aviation business. Unless the company keeps fixed costs low while operating within a low capacity, its bottom line will only continue to decline. This is will be further exacerbated by the large amount of cash it is expected to burn through in 2020.

However, it is also worth giving the company the benefit of time. Larry Culp is a highly regarded CEO, who has the capability to turn the company’s renewable energy and health divisions into cash cows over time. Given that there are opportunities available in both sectors, investors should hold their positions in GE stock and remain optimistic about the future.

As of this writing, Divya Premkumar did not own any of the aforementioned securities.

Article printed from InvestorPlace Media,

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