General Electric Investors Will Be Rewarded for Their Patience

Near-term storm clouds are gathering, but the stock looks like an excellent value for investors willing to ride out the volatility.

General Electric ‘s ( GE -0.69%) latest presentation highlighted a classic investment conundrum. What do you do with a company that’s subject to near-term risk around its earnings, but at the same time the stock also looks like a great value? Here’s a look at what management is saying and what it means to the investment thesis for the industrial stalwart. General Electric’s management speaks

CFO Carolina Dybeck Happe’s presentation at the Morgan Stanley Laguna Conference left investors doubting GE’s full-year guidance. Discussing trading conditions in the third quarter, Dybeck Happe noted “continued supply chain pressures” were causing deliveries to “move later in the quarter.” Consequently, free cash flow (FCF) is expected to be “in line with the second quarter.”

Let’s put some numbers to the commentary. GE’s FCF was $162 million in the second quarter, and its FCF for the first half was a negative (meaning an outflow) of $718 million. Assuming FCF is the same in the third quarter as in the second quarter (in line with Dybeck Happe’s commentary), GE’s year-to-date FCF at the end of the third quarter would be a negative $556 million.

In March, management guided for a full-year FCF of $5.5 billion to $6.5 billion. Fast forward to the second-quarter earnings, and management walked back this guidance , with CEO Larry Culp talking of a $1 billion push out of “free cash flow into the future.” So although management didn’t give a new range for full-year FCF, it’s reasonable to pencil in $4.5 billion to $5.5 billion for 2022.

Unfortunately, Dybeck Happe’s new update appears to imply that GE will need some $5 billion to $6 billion in FCF in the fourth quarter to meet that penciled-in guidance. The fourth quarter is always the biggest quarter for GE in cash generation. Still, given that the three-year average FCF generation in the fourth quarter is around $4 billion, it’s hard to see GE meeting even the penciled-in guidance discussed above. So don’t be surprised if GE misses its guidance this year. Why cash flow is faltering

No investor likes holding a stock that looks likely to miss its numbers. And certainly not investors who remember Jack Welch’s legendary tenure at the company and his focus on finding a way to meet management’s guidance. That said, it’s essential to understand why GE’s FCF is faltering this year.

It comes down to the same supply chain issues discussed above. In a nutshell, GE is struggling to deliver on its backlog of high-ticket items such as aircraft engines, healthcare equipment, and wind turbines. These are bulky items with complex supply chains that require a significant amount of logistics support to produce.

For example, Dybeck Happe said that aircraft engines “moved to the right,” meaning that GE is falling behind its delivery schedule. It’s a similar story at GE Healthcare, where revenue is 7% to 8% “lower than it should be” due to supply chain issues. Simply put, if GE can’t deliver on its backlog, it’s likely to suffer cash outflows as it needs to buy inventory and tie up cash in trying to manufacture products it can’t deliver. Why General Electric stock is a buy

But here’s the thing: This isn’t an issue of end demand. For example, Boeing and Airbus (GE and its joint venture, CFM International, deliver engines to both companies) are desperately trying to ramp up production. In fact, GE’s total aviation orders were up 29% on an organic basis in the first half compared to the same period in 2021.

GE Healthcare’s order growth is also strong (5% organic growth in the first half) and matches management’s outlook for mid-single-digit revenue growth over the long term. In fact, total company orders were up 8% organically in the first half.

Simply put, it’s not the same situation as in 2018 , when GE’s FCF weakened mainly due to a deterioration in gas turbine demand. The orders will eventually get delivered, and the supply chain issues will ease at some point. It’s taking a lot longer than many, including GE’s management, would have hoped, but that looks like it’s more than reflected in the stock price.

GE stock looks like a great value; just don’t be surprised if there’s some near-term downside, because meeting the company’s full-year FCF guidance is a challenge. Should you invest $1,000 in General Electric Company right now?

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