General Electric Could Actually Benefit From 737 MAX Grounding, Bear Says -- Barrons.com
By Al Root
General Electric remains a polarizing stock with bulls and bears firmly entrenched.
The date of the next battle will be July 31, when General Electric(ticker: GE) reports second-quarter earnings before the market opens for trading.
The focus will be on free cash flow. The problem for both bulls and bears is that the financial metric -- free cash flow -- can be volatile. What's more, GE Aviation cash flow numbers for the second quarter will be muddled by the Boeing (BA) 737 MAX grounding. GE and its partner Safran (SAF.France) make the engines for the MAX jet.
JPMorgan analyst and GE bear Stephen Tusa said in a Monday research report that the Boeing delays will actually be free cash flow positive for GE this quarter. In the aerospace business, large equipment -- such as aircraft engines -- are often sold at a loss with earnings and cash flow coming in as machines are maintained over the following 20 to 30 years. So GE will have less low-margin engines shipping and more high-margin parts sold than is typical for its aviation division.
The back story. Price targets at large Wall Street brokerages range from $5 to $15 a share for GE stock. The $10 spread is nearly 100% of the current share price. That illustrates the polarization within the analyst community. The average bull-bear spread for stocks in the Dow Jones Industrial Average is about 40%.
Bears worry the stock is ahead of itself and company earnings -- once GE businesses are sold and restructured -- won't justify the current price. Bulls think that the worst has passed for the company and earnings will improve under new corporate leadership.
The bulls have the upper hand so far in 2019. Shares have returned 39% year to date, better than the 18% return of the Dow over the same span.
What's new. The second quarter "will have an unusually low amount of loss leading equipment deliveries as the [737 MAX LEAP engines are] grounded with the MAX, with production likely shifting to highly profitable spare engine sales," writes Tusa in a Monday research report. He adds "a quick check suggests H-frame [power turbine] deliveries look light so far." Fewer new deliveries in GE Power could have the same impact as fewer new LEAP engines for GE cash flow -- a skewing to higher-margin parts and service revenues.
Of course, it's counterintuitive that lower deliveries are "good" for a company. It boils down to how accountants recognize sales and earnings. Both sales and earnings don't actually mean cash is coming in the door. Over time, higher deliveries are a good things for businesses, and every industry stakeholder, for instance, wants the 737 MAX flying again.
This situation is a warning for all investors -- both bulls and bears -- to not get too hung up on one financial metric such as free cash flow. After all, over time, cash flow should approximate earnings -- the key phrase being "over time."
Looking ahead. Tusa sees cash usage -- or burn -- of about $700 million in the second quarter. The company has guided to cash burn of between $1 and $2 billion. It's rare that a bear thinks the company will beat its guidance -- that's usually a good sign for investors.
Still, Tusa believes the fourth quarter will be toughest for GE this year because of "seasonal factors and higher spending to restructure GE business units." If he is right, that means there will be little movement between the bulls and the bears between now and early next year, when GE reports forth-quarter numbers and offers up 2020 earnings guidance.