What no one is talking about in GE's turnaround

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Analysts and investors agree on what matters most to
General Electric

(GE): cash flow and repair of the energy division in difficulty. This is not all that matters for the long-term success of the company.

Following the investor event on Thursday, a host of analyst ratings were released on the industry's free cash flow and the ability of CEO Larry Culp to raise the bar on GE Power. The company's earnings for 2019 – and why its earnings are not important – is another favorite topic for Wall Street analysts, as is debt reduction.

The four questions are important for GE, but investors should not forget another important element: parts and services in the spare parts market for the company's turbines, engines and healthcare equipment. Understanding this market can help predict what the cash flow will look like once the recovery is complete.

UBS analyst Peter Lennox-King follows the number of times different phrases are mentioned in the earnings calls. It's an interesting metric that illustrates the purpose of the street. In GE's fourth quarter earnings report released on January 31, the word "services" was not included in the top 10. "Cash flow" was the watchword of this call.

After Thursday's event, the services did not change much in the analyst's notes either. Melius Research analyst Scott Davis commented that free cash flow in the renewable energy sector was disappointing. "[The wind business] is super competitive and lacks the potential for after-sales service to compensate for the low [original equipment] profile, "he writes. Davis thinks GE could leave the renewable energy production sector.

As Davis's comment suggests, parts and service margins tend to be greater than original equipment margins. But how much higher? Consider an aerospace supplier
TransDigm

(TMD), whose operating margins are north of 40%. TransDigm makes the bulk of its sales in the aerospace parts market by replacing parts as they go.

Honeywell International

(HON), on the other hand, also has a significant aerospace parts and service business and a large franchise of original equipment. Honeywell aerospace margins are 23%, but far from TransDigm's level. During Honeywell's fourth quarter teleconference, management told analysts that the increase in original equipment shipments had weighed on aerospace margins.

We may use some of this information to gain a better understanding of GE's liquidity potential on its remaining industrial assets once most of the restructuring has been completed this year. Barron's believes that GE's remaining industrial assets could generate at least $ 6 billion in annual cash flow.

Is our number correct? Probably not. But it is a useful rule. And treat OEMs as low-margin leaders to predict future reframing the cash generation potential of the GE franchise. In other words, the losses resulting from the decline in market power mask potential higher margins for parts and services.

No one is talking about service margins at the moment, but if Culp manages to reduce fixed costs, service margins will be central in the years to come.

GE was not immediately available to respond to Barron's questions about margins of service. GE shares were down 2.9% on Friday afternoon at $ 10.00 and up 37.4% year-on-year.

Write to Al Root at [email protected]