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2017-07-21 14:35:02
G.E. Results Show Next Chief’s Challenges at Revamped Company

John Flannery will not formally assume the job of chief executive of General Electric until August. But he made a cameo appearance in an earnings conference call on Friday, and said he was conducting a rigorous review of each of the company’s businesses and would present his plans in November.

His analysis, Mr. Flannery said, was a big task across a large global corporation. He said he was “not worried about the company being dead in the water until then.”

G.E.’s quarterly results were certainly not those of a company dead in the water, but they pointed to the challenge ahead for Mr. Flannery. The profit and revenue were in line with analysts’ diminished expectations. Cash flow, after a surprising drop last quarter, rebounded.

But G.E. said earnings for the year would probably be at the low end of the company’s previous projection of operating earnings of $1.60 to $1.70 a share. That sent G.E. shares down about 4 percent in early trading.

The company’s financial performance continues to be hurt by the impact of low energy prices on its big oil-field equipment business. And as G.E. has sold off much of its once-huge financial arm, the contribution from GE Capital has shrunk as well — a streamlining by design as the company returns to its industrial roots.

G.E. reported operating earnings per share of 28 cents, a 45 percent decline from the year-earlier quarter, but slightly above the average estimate of analysts of 25 cents a share, as complied by Thomson Reuters.

The company reported a 12 percent falloff in revenue, to $29.56 billion, somewhat higher than the Wall Street average forecast of $29.02 billion. But organic revenue from industrial operations, which excludes one-time gains or losses from asset sales or acquisitions, increased 2 percent, to $28 billion. Industrial results are the crucial yardstick for G.E. now as its finance unit is pared back.

But the number that investors were watching most closely was cash flow. A Wall Street maxim states that earnings are an opinion, but cash is a fact. That is, big companies can often employ financial-engineering tactics to lift reported earnings.

Free cash flow — cash generated, minus capital expenses — can be a purer measure of the financial health of a business. For G.E., the cash flow numbers have been disappointing since last year. And in the first quarter, the company reported a negative cash flow of $1.6 billion from industrial operations, $1 billion below management’s earlier forecast.

G.E.’s executives said the shortfall was largely explained by the increase in inventory for orders on new products coming to market, including jet engines, power generators and locomotives. That capital-intensive buildup is a short-term drain on cash, but it reflects strong orders that later convert to sales and profit.

On Friday, G.E. reported free cash flow from industrial operations of $1.5 billion, a reassuring move into positive territory. Much of the company’s cash flow comes at the end of the year, because that is when industrial customers buy new equipment. Still, it will need a strong second half to achieve its forecast of cash flow of $12 billion to $14 billion for the year.

Investors are keeping a close eye on cash generation because G.E. has pulled back from its profit goal for 2018. The target for next year is significant because in 2015, when G.E. announced plans for shedding most of GE Capital, it also laid out its three-year plan for the company. It would pare back to its industrial core, and its earnings would rise to $2 a share by 2018.

On May 24, speaking to analysts at a G.E. conference in Florida, Jeffrey R. Immelt, the chief executive, recalled the 2015 plan and the years since. The oil and gas market, given the price declines, was “much tougher” than anticipated, he said. A bit later, referring to the 2018 profit goal, he said, “Two dollars will be at the high end of the range” of likely outcomes. Translated: scarcely a chance.

“When he had to talk down the number, that became a lightning rod for criticism,” said Deane Dray, an analyst at RBC Capital Markets.

Less than a month later, Mr. Flannery was named the new chief at G.E. After 16 years as chief executive, Mr. Immelt was expected to step down, but the timing surprised analysts.

On Friday, G.E. executives offered no guidance for 2018 earnings — that will come in November from Mr. Flannery. But Wall Street analysts have already scaled back their profit forecast for 2018 to $1.81 a share.

Under Mr. Immelt, G.E. has stepped up its expense reduction efforts under pressure from Trian Fund Management, an activist fund led by the investor Nelson Peltz. G.E. said it was on pace to cut its costs by $1 billion this year. Mr. Flannery pledged to accelerate the cost-cutting campaign.

G.E.’s new chief inherits a fundamentally strong company, with industry-leading businesses led by jet engines and electrical power generators. It is once again an industrial giant, and no longer one attached to a sprawling financial institution.

G.E. not only weathered the financial crisis but also made large investments. A crucial initiative has been to transform G.E. into a “digital-industrial” company, adding software and data analysis to its heavy equipment. The digital technology opens the door to predictive maintenance, lower fuel consumption, reduced carbon emissions and longer-lived equipment. G.E. has hired thousands of software engineers and developed a data collection and analysis software product. More than 100 of the world’s airlines have signed up to use it.

But the digital buildup has been costly. G.E. will have invested $6.6 billion, from 2011 through the end of this year, with most of the spending in the last two years, estimates Nicholas Heymann, an analyst at William Blair & Company.

Such investments, however, had a trade-off, as they sacrificed near-term profit for a hoped-for future payoff.

Mr. Flannery will now have to decide where to continue spending and where to cut.

“G.E. has great technology, but none of that means a thing if you can’t deliver strong profits from it,” said Scott Davis, a former Barclays analyst who is setting up a research boutique.