In 2018, General Electric's (NYSE: GE) adjusted free cash flow plunged by more than $1 billion year over year to $4.5 billion. That fell well short of management's initial guidance for between $6 billion and $7 billion of free cash flow. Moreover, CEO Larry Culp hinted on GE's earnings call in late January that free cash flow would deteriorate further this year.
Earlier this month, Culp shocked investors when he stated at an investor conference that free cash flow would probably turn negative in 2019. On Thursday, GE provided more detail on its outlook for 2019 and beyond. Fortunately, the company's 2019 cash flow forecast is not as bad as some had feared, and GE expects strong improvement over the next two years.
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Setting expectations for 2019
General Electric expects to produce negative free cash flow of up to $2 billion this year, despite delivering revenue growth and modest margin expansion on an adjusted basis.
There are a few reasons for this big discrepancy. By far the largest contributor to GE's projected cash flow decline is a surge in cash restructuring costs, as the company works to slim down its corporate overhead and power business in particular.
GE also expects cash flow at the power business -- which burned $2.7 billion of cash last year -- to fall deeper into negative territory in 2019. Aside from restructuring spending, the big cash flow headwinds here are cost overruns on projects that were approved with overly aggressive assumptions and legacy costs that are mainly related to acquiring Alstom's power business.
A third big reason for GE's projected cash flow decline in 2019 is that the renewables segment is expected to swing from producing around $500 million of free cash flow last year to burning cash in 2019. Working capital changes are driving most of this year-over-year headwind.
Management expects huge improvement in 2020 and 2021
In conjunction with presenting its 2019 outlook, GE's management stated that free cash flow should rebound well into positive territory next year, with further improvement coming in 2021. Of course, some skeptics worry that these projections are overly optimistic. Let's take a look at why GE executives are confident in a strong free cash flow recovery.
First, cash restructuring costs will start to decline in 2020 and will fall off significantly in 2021. Second, GE will see ample cost savings from these efforts by 2021. Management estimates that corporate overhead costs will be down at least $500 million relative to 2019. Overhead costs in the power unit could decline even more, while GE Power will also benefit from rationalizing its manufacturing and service footprint. Third, GE will work through most of its "non-operational" headwinds -- like legal settlements and unprofitable legacy projects -- over the next two years.
In fact, GE believes that its power and renewables segments will both produce positive free cash flow in 2021. For comparison, they are on track to burn $4 billion or more on a combined basis this year.
Asset sales will negatively impact cash flow over the next two years, but lower interest expense and organic growth in GE's healthcare and aviation segments should more than offset that headwind.
GE didn't quantify exactly where free cash flow will end up in 2021. However, it is likely to comfortably surpass the 2018 level of $4.5 billion -- with plenty of growth potential for future years as GE Power recovers further and GE Aviation continues its torrid growth.
GE stock has tons of upside
Investors cheered GE's outlook, sending GE shares up nearly 3% to $10.30 on Thursday. Still, that's below the high the stock hit a few weeks ago, after GE announced a $21 billion deal to sell its biopharma business to Danaher, which will allow the company to reduce its debt quickly. And it's nearly 70% below the multiyear high GE stock reached less than three years ago.
If GE can hit its 2021 goals and deliver further improvement thereafter, free cash flow could reach $1 per share by 2022 or 2023. That would potentially justify a GE stock price as high as $20.
This still wouldn't erase all of investors' losses of the past two years. However, those are sunk costs. After a 10-year bull market, there aren't that many stocks with a good chance to double over the next three to four years. Thus, GE stock could deliver market-beating returns for investors going forward.
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