Larry Culp stepped into an almost impossible situation last fall. General Electric, one of the most complicated companies on the planet, was falling apart. And GE needed him to save it.
Culp, the first outsider CEO in GE’s 127-year history, moved swiftly to chip away at the troubled company’s towering pile of debt. He slashed GE’s cherished dividend, sped up its divorce from oil-and-gas giant Baker Hughes (BHGE) and unloaded the BioPharma business for $21 billion.
But GE was never going to be a quick fix. The financially complex problems Culp inherited were decades in the making. Resolving them will take time.
And these aren’t the best of times for GE. The company’s comeback is stymied by powerful forces outside its control, including lower interest rates, the downturn in manufacturing and the US-China trade war. GE’s (GE) stock price has lost a quarter of its value since Culp was named CEO to much fanfare on October 1, 2018.
“It’s an impossible situation. There is no magic wand you can wave,” said Andrew Obin, analyst at Bank of America Merrill Lynch.
And yet Culp has earned high marks on Wall Street for quelling the crisis that engulfed GE, at least for now.
“He was dealt a pretty difficult hand. I’m not sure he could have done any better,” said Obin, who gives Culp an “A” for his first year in charge.
Culp expressed confidence in his ability to turn GE around by focusing on shoring up the company’s financial position while simultaneously strengthening its businesses.
“I’m more optimistic now than I was a year ago,” Culp said in a recent GE newsletter.
Frustrated by the pace of change under former CEO John Flannery, GE’s board brought in fresh blood by hiring Culp last fall. Culp, widely respected for his impressive track record while running Danaher (DHR), a medical equipment maker, brought instant credibility to a C-Suite that badly needed it.
“Before joining GE, Larry was viewed as the revered industrial CEO God,” said Nicole DeBlase, an analyst at Deutsche Bank.
That rock-star reputation raised expectations on Wall Street that he could deliver a speedy GE turnaround. The company’s stock spiked as high as $13.08 days after Culp’s was hired, or 37% above current levels.
“He’s handled things as well as he could. There haven’t been big missteps,” said DeBlase. “People would love to see faster progress, but quite honestly too quick is almost a bad thing. You need to be thoughtful when embarking on a turnaround as dramatic as this.”
Even some of GE’s biggest critics applaud the board for hiring someone with the credibility to restore faith in management.
“If Larry were not the CEO, the stock price would be four bucks,” said John Inch, senior analyst at Gordon Haskett Research Advisors. “To GE’s credit, they chose a CEO who has been able to instill confidence on Wall Street to prevent a ‘run on the bank.’”
Burning tons of cash
Yet GE is far from healthy, especially when looking at free cash flow, the metric that investors are most focused on.
The maker of light bulbs, jet engines and MRI machines burned through $1 billion in cash during the second quarter. That’s far worse than the positive free cash flow of $316 million the year before.
The troubles have been driven by GE Power, the division that makes turbines and systems for natural gas and power plants. The power division has been slammed by the rise of renewable energy and the shift away from fossil fuels. GE Power profits plummeted 71% during the second quarter.
But those numbers were better than Wall Street feared. And Culp had enough confidence in the future to do something that has been rare of late: In July, he raised GE’s full-year outlook.
GE also continues to restructure the power business, where fixed costs were down 10% during the first half of 2019.
“Are they making progress? I’m sure they are,” Inch said. “But are they out of the woods? Not by a long shot. They still have a mountain of debt.”
Shrinking GE’s pile of debt
GE’s stressed balance sheet is the product of years of poorly-timed acquisitions and questionable spending decisions.
But Culp has shown a willingness to make painful decisions aimed at cleaning up the debt-riddled books.
One of his first moves was to slash the company’s 119-year-old dividend from 12 cents to a penny. This week, GE announced it will freeze its US pension plan for about 20,000 workers and take other steps aimed at slashing the company’s alarming pension deficit by up to $8 billion. GE’s pension plans were about 75% funded as of the end of last year. The steps announced this week would lift that funding status to about 80% or higher.
“This move shows that GE is looking to pull any and all levers to restore its financial health,” Jim Corridore, an analyst at CFRA Research, wrote in a note to clients.
GE’s pension problems have been magnified by the recent decline in interest rates, which forces companies to assume lower returns for their pensions. Pension funds typically invest 40% or more of their assets in bonds such as low-yielding government debt.
Culp is forced to walk a fine line in repairing GE’s balance sheet.
He needs to raise cash quickly to calm the nerves of bondholders and prevent a potentially disastrous credit ratings downgrade. But Culp can’t be seen as conducting a fire sale. He needs to show shareholders there will still be something left that’s worth owning.
In February, GE sold its BioPharma unit for $21.4 billion. The business, which makes instruments and software that support the research and development of pharmaceuticals, was sold to Danaher, Culp’s former company. It is GE’s biggest sale since Culp became CEO.
JPMorgan warns GE Aviation is overvalued
Even GE Aviation, the company’s strongest-performing division, is under scrutiny.
GE has been affected by Boeing’s (BA) 737 MAX crisis, because a GE joint venture makes the LEAP engines used to fly the plane. The 737 MAX has been grounded by safety concerns triggered by a pair of deadly crashes. The situation will hurt GE’s cash flow by about $300 million a quarter, according to Deutsche Bank.
C. Stephen Tusa, Jr., the biggest GE bear on Wall Street, warned in a research report last week that investors are overvaluing GE Aviation while underestimating the business’s risks.
The JPMorgan Chase analyst argued GE Aviation’s weakening growth prospects make the division worth just $30 billion, less than half the price tag assigned by some Wall Street bulls.
GE Aviation is “closer to its best days being behind it than in front,” Tusa wrote.
Fighting fraud allegations, recession worries
Culp faced a major test over the summer when Harry Markopolos, who famously blew the whistle on Bernie Madoff’s Ponzi scheme, called GE a bigger fraud than Enron. GE’s stock took an 11% nosedive on August 15, its worst day since 2008.
But the company launched a counteroffensive against Markopolos, convincing Wall Street that the allegations are way off the mark. Analysts who follow the company simply didn’t see a smoking gun in the report, which has since been taken offline.
“We came to the view it was overblown. It’s not a fraud,” said Deutsche Bank’s DeBlase.
Of course, “not a fraud” isn’t a great selling point on Wall Street.
To move the company to the next phase of its comeback, Culp needs to prove that he can deliver improvements in GE’s results, particularly around free cash flow.
“It’s hard for me to bet my career and have a really positive view on GE when I don’t have confidence in free cash flow forecasts,” said DeBlase.
As a global manufacturer, GE’s fortunes are intertwined with the US-China trade war.
The tariff battle is deepening the global economic slowdown, causing manufacturing activity to contract and disrupting complex supply chains. Worse, it raises the risk of a downturn.
GE has suggested it is insulated from a recession because more than half of its revenue comes from the stickier business of selling parts and services to customers in the aftermarket.
“We like the way our business is structured going in to whatever may be in the offing here,” Culp said last month.
Still, history shows that highly-leveraged companies like GE fare worse during recessions.
“That’s a strike against GE if we go into a downturn,” said Inch.
And that may be biggest obstacle Culp must navigate as he tries to return GE to greatness.