Why Moody's Sees Near-Term Risk With General Electric

By Markets Fool.com

Moody's Investors Service recently released a report on General Electric Company highlighting the elevated near-term risk in GE's investment programs. To be clear, the report also outlined that the investments should leave GE "well positioned" in the long run, but I want to focus on the near-term issues.

Continue Reading Below

What were the reasons behind the elevated risks discussed? And what are investors to make of them?

General Electric Company has high hopes for the LEAP aero-engine. Source: CFM International website.

General Electric Company faces changes
It's well known that the company is in transition. As readers already know, management plans to divest assets from GE Capital and refocus the company on its industrial businesses. The integration of Alstom's energy assets is a key part of the process.

Meanwhile, management is engaged in the ongoing development of its "industrial Internet" and developing its industrial services business.

Continue Reading Below

Moody's report
Clearly, it's a period of significant transition, and Moody's report,titled "General Electric Company -- A Credit in Transition: Elevated Risk Profile Near Term, but Well Positioned for the Long Term," also highlights the execution risk in the investment programs in some of its businesses. For example, quoting from the press announcement relating to the report:

Cash-consuming programs such as next-generation locomotives, aircraft engines and heavy-duty industrial gas turbines will constrain cash flows over the interim, as will higher returns to shareholders.

Essentially, the near-term risk is that all of these activities carry execution risk and could constrain free-cash flow generation in the near future -- obviously a key concern for a bond credit rating agency, as companies need cash flow in order to service debt.

Why you don't need to worry
The execution risk inherent in divesting GE Capital assets is one thing, but investors should feel somewhat comfortable with the Alstom integration and the other investment programs. Moody's release mentions references locomotives, aircraft engines, and industrial gas turbines.

Indeed, at a recent conference, CEO Jeff Immelt referred to some of these programs in answering a question from UBS analyst Shannon O'Callaghan:

We were in, over the last five years, an incredibly heavy ramp-up in aviation, power and global. So you are building factories in Nigeria, you are doing all the tooling for the LEAP, the GEnx, the H-turbine, things like that

The interesting thing about these programs, and the Alstom integration, is that they are all in areas of core strength for GE. In other words, I would argue that investors should feel more secure about the risk in investment programs because GE management is playing within its strengths. And there is evidence to prove that the company is on the right track with all of them.

GE's investment programs
For example, at the recent Electrical Products Group Conference, Immelt outlined that management now expects $3 billion in cost synergies by the fifth year of the Alstom deal, compared to its initial estimate of $1.2 billion.

Moreover, GE's new H-turbine, known as the HA, is set for its first delivery in July. Immelt argued that the large scale and heavy-duty segment of the gas turbine market (the H-segment) now represents 30% of the market and is "the only segment of the market that is growing right now" -- good news for GE as it looks to expand orders of its new turbine.

General Electric Company's new HA turbine. Source: General Electric Company website.

Turning to aircraft engines, Immelt claimed that its CFM International's (a joint venture between GE and France's Snecma) LEAP engine has 79% marketshare, implying that it's competing well with with International Aero Engines on the Airbus A320, and with United Technologies' Pratt & Whitney's PW110G on the A320neo.

Meanwhile, according to Immelt, GE is ahead of the competition on Tier 4 (a tighter emission standard) locomotives -- he outlined how GE had a "very strong leadership in the Tier 4. The only one that is approved that will ship this year" -- ahead of Caterpillar,which might not have its Tier 4 locomotives available until 2017.

The takeaway
All told, Moody's is right to highlight the near-term risk, and also the long-term opportunity inherent in these investments. Indeed, GE still has execution risk with its investment programs, particularly as production is ramped up on LEAP engines, the HA turbine, and Tier 4 locomotives.

However, these areas are in GE's core competency. Early indications look positive on all of these programs, and the upgrade to expectations of cost synergies from the Alstom deal is a timely reminder of what can be achieved when GE focuses on its areas of strength.

The article Why Moody's Sees Near-Term Risk With General Electric originally appeared on Fool.com.

Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.