Today I’m pleased to welcome GE’s Chairman and CEO Larry Culp to this newsletter for the first time.
Many investors have noted to me that GE is marking its one-year anniversary since Larry joined as CEO. While it may be a short milestone on a long journey, questions I keep hearing include “Where is GE in its recovery?”, “What’s changed inside the company?” and “What will success look like?”
Larry took some time to answer these questions and others, and our conversation is below. While not inclusive of every issue that I’m sure is on your mind, I hope hearing some of his perspective firsthand is helpful before everyone gets consumed by earnings season. We’ll talk in much greater detail on October 30th when GE reports its third-quarter earnings.
As always, I welcome your feedback. Thank you for your interest in GE.
Steve Winoker (SW): Can you tell investors more about GE’s cultural evolution? How far have we come as a company and where are we headed?
Larry Culp (HLC): Steve, first I’d like to just thank all of the investors who have offered their thoughts and counsel to us over the last year. We’re listening and intend to continue the dialogue as we move forward.
To your question, as my friend Jim Collins might say, “This is a good start.”
Coming to GE as an outsider, I wanted to take some time from the start to learn and listen, not automatically execute a playbook that worked elsewhere. What I’ve learned is that we have an enormous opportunity to drive sustainable performance improvements across each of our businesses.
We’ve started, but there’s a lot more work to do. I’m most encouraged by how our team has embraced discussions around fostering greater candor, transparency, and humility. Putting the good and the bad on the table in equal measure is not always easy, but it is critically important. For example, our operating reviews today now start with a much more balanced “what’s working and what’s not” than I recall last summer when I was a director. I’m encouraged by this progress.
We’re doing this at the Board level as well. 70% of our members are new additions to the Board since 2017 and 40% are women, bringing a fresh perspective and diversity of thought and experience to bear on GE’s challenges. All of us are provoking lively debate and interrogation on every possible topic.
If that is the “soft side” of what we’re trying to evolve and improve, there is a “hard side” as well. You’ve heard me talk about how important it is to focus on our customers, strengthen our operational bias, and prioritize what we’re going to do based on what will drive the greatest impact.
What does that mean in terms of what we actually do? This is where Lean applies to more than just manufacturing. Part of the change is bottom-up; using kaizen, or activities that help us continuously improve, to manage our business more holistically and make changes that improve our operations. And part is top-down, as we increasingly adopt Hoshin Kanri, or the alignment of actions with strategy, to keep us hyper-focused on the priorities that can drive the highest returns. Taken together—measured via more standard KPIs and woven throughout the year in an ongoing sequence of operational, talent, strategic, and budget reviews—this is how we are running GE differently.
This kind of operational transformation, which encompasses a cultural transformation of its own, is going to take time to play out. What we are doing now is changing the conversation.
SW: How do you assess GE’s progress on the two concrete priorities you have articulated—improving GE’s financial position and strengthening our businesses?
HLC: Let me start by saying 2019 is still very much a reset year for GE. We said we would focus on those two things—and we’re doing what we said we would do. I’m encouraged by our progress.
Our first priority is to improve our financial position. Simply put, we have too much debt, and as I promised we are working to reduce it thoughtfully and soon. We have made good progress here. We have sold about $6.7 billion of our stake in Baker Hughes, leaving us with an approximately 37% stake that we plan to exit in an orderly fashion over time. When you combine both of these with our $6 billion exit of Wabtec and our pending sale of BioPharma, this sets us up for about $38 billion of cash to go towards paying down our Industrial debt. Remember that in the past year we also restructured the Wabtec deal to get more cash in the door and made the difficult but necessary decision to cut GE’s dividend, which saves GE about $4 billion per year.
Now we are putting that cash to work. We began by tendering $5 billion of our outstanding GE Industrial debt. We’ve shared that we’re considering additional actions, including but not limited to funding the pension and paying down GE’s intercompany loan with GE Capital, allowing Capital to pay down external debt.
The Capital team is also on track to meet its target to reduce assets by $25 billion between 2018 and 2019, giving the team about $40 billion in total sources to bring Capital’s debt-to-equity ratio down as well. And we’ll continue to take actions to achieve the deleveraging targets we’ve laid out in both Industrial (<2.5x net debt/EBITDA) and Capital (<4x debt/equity) by 2020. By reducing these leverage levels, we will position ourselves to play more offense going forward.
Our second priority, strengthening our businesses, is what takes longer—both in how we run them day in and day out and how that translates into results. From the start, we’ve talked about pushing more decision-making to the businesses to drive greater accountability going forward. Our culture discussion a moment ago is an important piece of this too, and across our businesses we’re working to drive a keener focus on our customers, manage for operational performance first, and set fewer, more impactful priorities.
SW: On that point, can you take us through the businesses? What are some of the dynamics you’re seeing across the portfolio?
HLC: First and foremost, GE is a company with industrial strength. Our backlog stands at $375 billion, ex-BHGE, which is up double digits versus the prior year. Our expansive installed base allows us to be in intimate daily contact with customers, helping them solve the problems that they're facing, and this in turn drives over half of our revenue. This positions GE uniquely well, especially against the backdrop of an uncertain global economy. We’ve also had three consecutive quarters of 5%-plus Industrial organic growth.
That said, we started the year saying that we could see up to $2 billion of negative free cash flow in 2019 and that we’d see significantly better results in 2020. We have already improved our outlook, but we must maintain a high sense of urgency on free cash flow. This challenge is not for one or two businesses, but for all of GE.
Looking across our portfolio:
- Power is focused on daily execution and working through cost structure to make the business more competitive and profitable. In the second quarter, we saw early signs of stabilization and spent less on restructuring than originally planned. This performance was a major driver in our decision to raise our outlook in July.
- At Renewable Energy, we are seeing strong order and revenue growth as we execute a steep production ramp. We need to turn around our Grid and Hydro businesses, and we’re focused on improving profitability across our Renewables businesses.
- In Aviation, currently celebrating its 100th anniversary, our investments have resulted in breakout innovations, including the LEAP, GE9X and T901 engines. We are actively managing the CFM-LEAP engine transition, which continues to pressure our margins as volume ramps and the engine comes down its cost learning curve.
- The Healthcare team is laser-focused on closing the BioPharma deal, which is key to our deleveraging plan. Growth can be a bit more volatile here as Healthcare is mostly shorter-cycle in nature, but we are focused on driving innovation to continue leading in precision health.
- Our focus at Capital continues to be making the business simpler and smaller, and Capital’s capabilities remain a key component to catalyzing growth and supporting customers in our end markets. Also, we are actively managing Insurance liabilities with a new team and better execution.
All in, we expect significantly better results in 2020 and beyond and we see an opportunity across each of our Industrial businesses to drive higher free cash flow margins over time. In 2018, our four Industrial businesses collectively yielded mid-single-digit cash on sales. At Aviation and Healthcare, we are focused on growing new platforms and services; at Power and Renewable Energy, we are also driving better project underwriting and execution and productivity. Over the long term, as operational improvements take hold, I have confidence that our Industrial businesses in aggregate should yield cash on sales more than double last year’s levels.
SW: If that’s what we are playing for, what are your watch items?
HLC: As we’ve shared with investors, several items are still in process for us, including our annual GAAP loss recognition insurance test, the impact of deconsolidating BHGE in our financial reporting, and our annual goodwill impairment testing. We’ll talk about each of these in more detail when we report the quarter at the end of October.
We’re also keeping a close eye on dynamics playing out outside our company, including prospects of sustained macroeconomic weakness, trade and tariffs, the 737 MAX grounding, and lower market interest rates, which represent a headwind for both our pension and long-term care insurance obligations. Broadly, our long-cycle structure helps us navigate changing macroeconomic environments. Given over half our revenue comes in the aftermarket, tending to our customers around that installed base helps us withstand some of that pressure—as long as we also reduce our debt and improve how we run our businesses.
As I said at the start of my tenure, we are committed to being as transparent as we can about the risks we face and make sure that we demystify them as much as we humanly can. We have taken initial steps with enhanced disclosures in our 10-K and 10-Qs, as well as the Insurance teach-in earlier in the year, and we will continue to look for opportunities to improve moving forward.
SW: What gives you confidence in the future of GE?
HLC: We have a lot more to do to make sure that GE is not only a good investment for everyone who reads this newsletter, but also for our customers, employees, and all our stakeholders.
We come at it from a position of strength. GE’s history, brand, and reach around the world are our biggest differentiators. We have an exceptional team committed to this and customers who are rooting for us.
The size, scale, and technology in our core four Industrial businesses are critical. I talked about our global installed base and backlog; we’re setting ourselves up to grow it over the coming years with important announcements like Power’s 100th HA order, announced yesterday for MYTILINEOS’ Agios Nikolaos power plant in Greece, and Renewable Energy’s agreement this morning with Dogger Bank for the Haliade-X to power 3.6 GW of the world’s largest offshore wind farm. Aviation continues to renew its major platforms, which have led to major commercial and military wins. Healthcare also continues to introduce new products, like its AI-enabled Critical Care Suite, to lead in precision health.
These technologies put GE at the forefront of our industries and represent the fruits of decades of investments that continue today. And the core areas that tie our businesses together—digital, additive manufacturing, GE Research’s advanced work in technology, GE Capital’s financing model, and GGO’s market access—help catalyze new areas of growth for GE.
This foundation, combined with the opportunities we discussed earlier to improve margins and cash flow, gives me great confidence in the inherent value that is within our power to unlock at GE. And I’m more optimistic now than I was a year ago that we can deliver it.
SW: Thanks for your time, Larry. More to come on October 30th.
Top image: Culp (center) and Winoker (second from the right) during a visit of a GE Aviation plant in Durham, North Carolina. Image credit: GE.