Following the release of General Electric Company’s (NYSE:GE) Q2 earnings report, pressure is growing for it to revise its 2022 guidance.
Due to supply-chain issues and inflation, General Electric reduced its free cash flow forecast for 2022 by $1.0 billion in that earnings report, making the company’s earnings prospects much more expensive almost immediately.
For businesses like General Electric Company (NYSE:GE), which utilize a lot of raw materials to produce engines, turbines, and other equipment that industrial firms sell to clients all over the world, inflation will continue to be a major problem.
There are very few to no positive catalysts for General Electric shares at this point because the company’s free cash flow forecast for 2022 has been significantly reduced and the economy is likely about to enter a recession.
For Now, Aerospace is General Electric’s ‘Ace in the Hole’
The firm is feeling the pinch from inflation, which raises the cost of raw materials and reduces profit margins, despite positive developments in the aerospace sector, which led to excellent order (+26% YoY) and revenue (+27%) growth for General Electric in the second quarter.
In contrast to Renewable Energy and Power, which posted YoY revenue decreases of -23% and -2% for the second quarter, respectively, only GE Healthcare had YoY sales gain of 1%.
Strong success in the aerospace sector resulted in a 1,510 bps margin rise to 18.7%. No other industry produces a bigger profit margin for General Electric than aviation.
Results for the second quarter of 2018 by General Electric were stronger than anticipated, mostly due to the Aerospace division. Earnings per share for the industrial company came in at 78 cents, substantially above estimates of 38 cents. Sales came in at $18.65 billion versus a forecast of $17.38 billion, exceeding forecasts as well.
‘Free Cash’ Got More Expensive
The macroeconomic environment is forcing the industrial juggernaut to be a little more cautious with its free cash flow. The company now expects between $4.5 billion and $5.5 billion in free cash flow for the current year.
General Electric Company (NYSE:GE) has not disclosed its free cash flow projections for 2023, but earlier statements have indicated that the company anticipates $7.0 billion in free cash flow for the following year.
The updated 2022 guidance accounts for, among other things, increased working capital needs for orders General Electric is placing for renewable energy.
Reduced free cash flow in any scenario always translates into a higher value multiple. In comparison to a 13.3x multiple before earnings when the market was still certain the guidance held at $5.5-6.5 billion, General Electric has a 16.0x free cash flow multiple based on $4.5-$5.5 billion in 2022 free cash flow.
Given that the U.S. economy appears to be heading into a recession and that inflation may cause General Electric’s profit margins to contract in the future, the company’s current valuation may be excessive for a cyclically exposed industrial sector.
However, GE Could See a Higher Valuation
Later this week, the first estimate of U.S. GDP growth will be made public. The GDP of the United States dropped by 1.6% in the first quarter, and if it continues to decline in the second quarter, the country will be officially categorized as being in a recession, which could significantly lower General Electric’s growth chances.
Having said that, General Electric Company (NYSE:GE) and its individual businesses would fare well if the US economy developed unusually strongly in the second quarter and avoided a recession.
Inflation most likely hit a new high of 9.1 % in June, seriously harming the economy. Cyclical businesses like General Electric Company (NYSE:GE) are probably going to struggle, despite the fact that this week’s GDP data is just the first reading and may be revised later when more information becomes available.
The Verdict on GE
At the beginning of what may turn out to be a protracted economic slump, you don’t want to possess an industrial conglomerate with erratic profitability and free cash flow.
The unpleasant takeaway from General Electric’s earnings was that the firm had to reduce its free cash flow prediction for 2022 by $1.0 billion, reducing the company’s free cash flow outlook despite the Aerospace segment’s good performance and rising profit margins.
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