General Electric Company (NYSE:GE) Morgan Stanley's 11th Annual Laguna Conference September 14, 2023 10:35 AM ET

Company Participants

Rahul Ghai - CFO, GE Aviation

Conference Call Participants

Joshua Pokrzywinski - Morgan Stanley

Joshua Pokrzywinski

Good morning, everyone. Welcome back to day three of Laguna. Thanks for bearing with us. I know it's a bit of a slog, but as they say, if you're going to hoot with the owls, you got to soar with the eagles. Thanks for joining us this morning. We're going to kick off with the team from General Electric. I'm joined on stage by CFO, Rahul Ghai. Rahul, thanks for joining us. Always a pleasure.

Rahul Ghai

Appreciate you guys having us here.

Joshua Pokrzywinski

Absolutely. No, I wouldn't miss it. Maybe you could just start us off with a bit of an overview of what you're seeing. Any other kind of prepared remarks you want to make, and then we'll dive into some Q&A, if that works.

Rahul Ghai

Yeah, absolutely. So listen, I'm excited. Excited as we get ready to launch two new public companies, Vernova and GE Aerospace, along with just driving performance, both for 2023 and the medium-term, and on separation, the momentum is building.

Steve and I were just together at our Greenville facility in South Carolina with 125 of our colleagues, as we prepare for departure. And people are jazzed. I mean people are jazzed about the culture we are building about what Lean can do for them and how it can drive operating performance and what a stand-alone public company means for GE Aerospace. So all three fronts, people are really excited.

And as we think about Vernova, clearly, the senior leadership team is coming together. We just made two big appointments, Ken Parks, as the CFO, three-time sitting public company CFO. I've known Ken for 20-plus years from the days at UTC together. He's going to be a great partner for Scott, fantastic add to the team; and Vic, who's been running onshore wind for us and has driven a remarkable turnaround in that business.

I mean you think about what the business looked like last year with $1.5 billion approximately of losses to breakeven this year in the second half, an improvement in 2024. I mean that's a huge turnaround, and now he's going to run all of Wind. So two key senior positions getting filled there. And then in terms of just the mechanics that are needed to separate two companies, legal entity separation, Form 10, all that, everything is on track.

And then with the work that Larry, Carolina and rest of the team has done in terms of the significant deleveraging that you've seen with the repayment of debt, and now we're just adding to that by this month retiring the rest of the preferred equity. We continue to liquidate our equity stakes, including actions earlier this week. So this just gives us significant capacity to ensure that both Vernova and Aerospace have a strong balance sheet that achieve investment-grade ratings.

And with Vernova, they're going to spend with a net cash position when we launch them. So really excited, proud of the work the team is doing on separation. So really, really good. Two leading industrial franchises in their industries, both with majority of the revenue coming from services. So things can be better set up for both businesses.

Now switching to performance. I mean let's talk about Aerospace first, continue to build on the leading positions that we have in commercial and defense propulsion systems, services, all of that. And as we think about what's happening in 2023, clearly, the demand is very, very robust. And we're trying to ensure that we meet the ramp expectations from our customers on the defense side, on the air framers with the airlines. So a lot of work is going in there and things are looking good.

And for commercial, we expect OE, we expect mid to high 20s. Services, given the robust market outlook and the disciplined execution, we expect more than 20% growth in services. On the defense side, we continue to innovate the future of combat. The book-to-bill has been really strong. Book-to-bill in the first half of the year has been more than 1.3. So that ensures robust and continued revenue growth in the outer years.

And if you look at both the House and the Senate, excited about the funding of the advanced engine development for the F-35. So things are looking good there as well. So overall, just it's a good place to be for GE Aerospace. And if you switch over to Vernova, as I'm getting to learn the business, I'm just impressed by the secular demand drivers and the execution that Scott and team are driving.

What they are doing with Lean is just absolutely amazing. I was at their Greenville facility last week with our Board, and just getting to learn how they manage outages. I mean what they've done to fix an outage in the field, they've taken 25% of the time out. They've digitized the whole process, so every technician out in the field has -- instead of getting paper on how to fix an outage goes out with an iPad and knows exactly what to do to talk about standard work and then can provide feedback to the people back home on what needs to get better.

So talk about continued improvement. I mean it's just a remarkable thing. They have standardized the tools, created new tools, have dedicated crews. I mean this is absolutely remarkable. So you think about what that does for the business, double-digit cost reduction, incremental capacity to do all that. And that's what gives us confidence that power will remain on track.

And if you switch over to the Renewables side, as I said earlier, turnaround in onshore and grid, breakeven in the second half of the year, continued improvement in 2024. Offshore, we're just working through the challenging backlog that we have right now. It's going to take some time, but it remains in line with the expectations that we had outlined back in July.

So you wrap all that up and say, okay, what does that mean? For 2023, we had a fantastic first half EPS that was greater than all of 2022, free cash flow improvement of more than $1.5 billion over last year. So really, really strong first half, gave us the confidence to raise our outlook for the rest of the year on revenue, EPS, free cash flow. So really good on all fronts. And as we sit here today, the aerospace services continues to do well.

Renewables and power are on track. So we think we are tracking to the higher end of our EPS and free cash flow guidance for the third quarter, so that's good. And we are in the middle of our strategy reviews right now. And as you go through these strategy reviews, it clearly highlights the both significant opportunities and strength of these businesses. So things couldn't be more -- things could be better. Really excited about where we are and what lies ahead of us.

Question-and-Answer Session

Q - Joshua Pokrzywinski

Excellent. It sounds like you guys have a lot of momentum, obviously, top to bottom in the organization. I think the one piece that folks struggle within the context of commercial, particularly Commercial Services, is that demand has been so strong. Clearly, there are bottlenecks in the system, some of what you guys have experienced, some of which come from your suppliers or others in the space.

I'd like to spend a few minutes if we can, just trying to understand maybe where some of those friction points are and how we should think about that in the context of GE. So maybe just to rewind a little bit to 2Q. Commercial Services up 30%, internal shop visits up 10%. I know there's a lot going on with spare parts and probably some price and other pieces in there. What are the pieces that we really need to be cognizant of in kind of watching or that you're watching just to try to understand how those two may be coming to alignment over time or how that divergence continues?

Rahul Ghai

Yeah. So on services, just to kind of set the stage, we raised our full year expectations. So now we think we're going to be growth of more than 20%. Most of that is going to come from a robust spare parts demand. So spares, when we started the year, we were thinking high teens to 20%, now we think spares growth is more than 20%. And it's coming from a couple of places. One, the departure growth is now stronger, right? I mean we got into the year thinking, hey, it's high teens year-over-year growth. Now we think it's kind of 20%, something like that. So the market environment is a little bit better. Plus, what we've really seen is a really good execution by the team in terms of pricing discipline, driving price increases in the market. So that is helping.

The other part is that the demand out of China was really robust. I mean if you go back to 2022, things were completely shut down. So huge catch-up in the first half of the year as China departures come back. I mean China departures are probably going to be up double over last year, close to, right? So a huge uptick in China departures. So that's driving demand out of China. And then the customer mix is good as well. So all that -- so the spares outlook looks better today than it did back in Jan or back in April.

On the shop visit side, we started the year thinking, hey, it's going to be somewhere around the 20% mark. Now the demand outlook continues to be really strong. As I said, departures are looking better, all that. The challenges comes down to supply chain shortages and challenges. So the turnaround times are longer than we expected. So with that, we think the shop visits this year are kind of more in the mid-teens than closer to 20%. So that's what we are thinking on shop visits right now.

But all that it's doing is it's just pushing the demand out. I mean the demand is not going anywhere just like we were expecting high-single digit growth between '23 and '25 when we were out in Paris on shop visits. Now it's just going to be north of that because some of the shop visits that we're going to do this year have been pushed out. So overall, I think the service looks really good. I mean the fact is that 20% plus growth this year is going to be good. And on the OE side, we raised our outlook as well. And now we're thinking it's mid-20s to high 20s.

Joshua Pokrzywinski

Understood. Following up on just a couple of things you mentioned there. I guess first on spare parts. Obviously, spare engines in a different discussion there entirely not have a lot of extra lying around the cell even if you wanted to. But on the parts side are folks building up inventories. I certainly understand there's a lot of different other points of friction there. Is that something where there's going to be a normalization or is that just really emblematic of how strong demand is.

Rahul Ghai

No, it is emblematic of how strong demand is and how we're driving the business. So keep in mind that in that, part of the reason why spares -- spare parts growth, just to be clear, it's different than spare engine, spare parts growth is more than departure growth is just coming from the pricing discipline. So there's a part of that it's just like, okay, we are driving -- we are doing a much better job of managing the demand. Customer mix is a factor.

So we monitor the inventory situation in our MRO shops very, very carefully. And we have a very, very good insight into how much inventory each of our MRO partners are carrying. And so we don't see any buildup. And that's where we feel, as you look between '23 and '25, we do expect the commercial business to be up mid-teens between -- over the next two years.

Joshua Pokrzywinski

So I want to -- the other thing I wanted to follow up on was that price comment. Clearly, there's so much tightness in the system that definitely affords a more forward look on price. Does that tend to be sticky? So at some point, hopefully, we come into greater balance. Are you going to get people knocking on your door at that point in time or does price tend to be fairly sticky once you get it?

Rahul Ghai

So it is fairly sticky. Historically, we've driven price kind of in the mid-single digit range. So that's been the historical trend or, of course, the last couple of years, inflation has been high, so the price increases have been higher than normal. Now as we look forward into '23 to '25, we do expect the outlook that we've shared -- that you shared for 2025 in terms of $2 billion of profit growth, that factors in mid-single digit price increase. So price increase is going back to historical norms. So we kind of -- as the inflation comes down, we do expect the price increases to come down as well. So that's what's built into our outlook that we provided for '25.

Joshua Pokrzywinski

Understood. And I do think there is some concern kind of lingering in the background and maybe air traffic slows just because it's been so strong. Clearly, with all the shortages in the industry, you can still grow through that and obviously, fleet age and GE's fleet age specifically, falls into that. But do you need sort of a specific flight hour or air traffic backdrop to support that '25 outlook or is that a little, call it, decoupled from air traffic in the medium term?

Rahul Ghai

So what we are expecting between '23 and '25 is kind of that mid-single digit plus kind of traffic growth. So that's what we built in. So it's not the 20% that we are seeing this year because we clearly expect, okay, there's a recovery in '23. We're getting back to 2019 levels, things are stable. China is coming back. So China is a big contributor to the growth this year year-over-year. But as we get into '24, China continues to drive overall departures. But we do expect that, hey, it's kind of in that high-single digit range maybe for '24, maybe go down to mid-single digit for '25. So that's kind of what's baked in here, so more normalized growth.

And then in terms of the other drivers, so other drivers, I spoke about the pricing. And we spoke -- we touched on the shop visits earlier, right, that shop visits have actually lagged behind departures growth. So if you look at between 2019 and 2023, even though air traffic is now kind of back to where it was in '19, the shop visits are not back. Shop visits are still trailing where they were back in 2019. So there's a little bit of catch-up that's going to go into '24 and '25. So you put all that together, that gives us confidence that services continues to grow.

And then the commercial we're going to lead that mid-teens growth because you see the demand out there for new engines, that is clearly, we said about 1,700 LEAP engines this year and then 2,000 for next year and then growth from that point on. So LEAP engines continue to grow, and that drives the commercial growth as well.

Joshua Pokrzywinski

Got it. And I do want to spend a minute on LEAP here, if we can. We're going to be approaching breakeven here over the next couple of years. How should we think about the timing of that? And I guess, maybe sort of the sub part B to the question is, competitive landscape might be changing here a little bit. Does that accelerate maybe the path toward breakeven on something like better pricing power or just higher win rates?

Rahul Ghai

Yeah. So just to level set the stage and then we can get into the recent events there. What we've previously communicated, service becomes profitable next year, and I'll come back and speak another word on why. Overall program becomes profitable in 2025 and then OE becomes profitable in '26. So that's kind of the trajectory we are on. So why do we feel good about the services profitability for next year?

A couple of things. One, we start getting into now a revenue recognition shop visits, right? So far, we've been majority quick turns. We haven't done a lot of restorative shop visits. Now as we get into '24, we start that, so that drives a certain amount of revenue recognition. We've also previously said, as we've encountered some problems and challenges on the launch, whether it's a radial driveshaft, higher-than-expected shop visits in the Middle East, we've been taking specific warranty reserves or specific reserves, I should say, on those events.

Now as we get into '24, the performance is getting better. We don't need to take the same level of reserves, and those costs that are coming in are going to get charged to those reserves. So put that together, we feel that, hey, we can drive LEAP service profitability into '24, and that just goes from that point on. And you've seen what we said on the nx back at Paris. With the nx, our profit margins are 4 times in a 10-year period. So we're doing, following the exact same playbook on LEAP. So the margin should grow from that point on, and we can come back if you want on that topic.

On the recent events, it doesn't change much on LEAP for the near term. We are very -- we feel we're in a good market spot right now. So it shouldn't change much for the near term because clearly, we're living in a supply-constrained environment. So we are trying to do the best we can to meet airframer expectation, airline expectations, so no change expected in the near term.

Joshua Pokrzywinski

Understood. And then just sort of zooming out on LEAP. Generationally, a tough comp versus CFM56. So I think best engine ever created by a man. How do you get comfortable with the aftermarket kind of life cycle value there compared to LEAP? Obviously, LEAP has a couple of different designations that don't have a lot of part commonality, certainly a more complicated engine. When will we know sort of how that aftermarket profitability compares to something like 56?

Rahul Ghai

Yeah. So it's a great question. First, I would say, again, let's spend a minute on nx and because it should -- our belief is it should follow the same trajectory. You launch a program, there are always some issues, right, and you get the performance figured out first, right? You get that done. As you go deeper into the life cycle of a product, you drive productivity when an engine comes for shop visit. So the turnaround times continue to shrink over time.

You embed advanced technology in those shop visits as well, right? So -- and actually, we did foam washing. That takes a huge amount of cycle time out of the process. So -- and then you kind of work on the contract restructuring, the pricing, all that other things go in. So that's the playbook that we followed in nx and that is where we felt if you look between 2012 and 2022, the profitability was up 4 times.

And on LEAP, it's the exact same playbook, right? So the playbook on LEAP is going to be exactly what we did on nx. So there's no reason why we should not see improvement on LEAP profitability, and that's where our strategic plan would suggest they become profitable in '24. It improves from there in '25 and then continues to grow from that point on in terms of margins on the LEAP service revenue into the latter part of this decade.

Joshua Pokrzywinski

Understood. And then maybe just to wrap up kind of the fundamental performance on aero on supply chain. Obviously, you mentioned several times, every one of them is aware of just how tight that is for the industry. What are the areas that would be particularly helpful to improve from GE's perspective? If you could just wave the wand, say the Latin. Is it the forging and casting? Is it more the service labor? Where would you kind of like to see the most improvement? That would be helpful.

Rahul Ghai

Yeah. Listen, supply chain is -- it's across a lot of different factors. It's not in one area. If it was in one area, it would be easy. It's across multiple fronts. It's on electronics, it's on forging and casting, it's across multiple fronts. So I think everybody is working really hard trying to meet the demand. Keep in mind, I mean, you look at what happened in the second quarter, our LEAP engine output up 80% year-over-year, right, and commercial total output up more than 50% year-over-year. And if you look at our material deliveries, material deliveries were up kind of low double digits, right?

So we drove a huge amount of engine output increase on a fairly decent material input increase, but not to the same level as the commercial output increase. So clearly, there's a lot going on there where we are trying to drive Lean in our facilities, making sure that we are reducing our cycle times. We understand what's coming. But we need that material inputs to grow. And it needs to grow across, to answer to your question, it needs to grow across multiple different areas. So that is what we're dealing with.

I mean if you look at, we've previously spoken about the engineering help that we are providing to our vendors. I mean that number is up 30% year-over-year in the second quarter, probably in the first half, so -- and sequential step-up in the second half of the year. So we are doing everything that we can to work with our vendors, making sure they get the support the need from us. So it's a work in progress, both on availability of skilled labor and then on output from the Tier 3, Tier 4 vendors that moves up the supply chain.

Joshua Pokrzywinski

Understood. And then how should we think about capital allocation for Aerospace over the next few years? I mean obviously, the balance sheet is in much better shape. Is there an appetite for M&A? Obviously, there are some niches like systems where we talk about it a lot, but these are large businesses, maybe some fragmentation out there in the market. What do you guys see? What's interesting to you?

Rahul Ghai

Listen, first, I would say, as we sit here today, we feel really comfortable with the position we are in, right? I mean if you look across the no burdening platform, then no itchy fingers, I mean, we feel really comfortable with the position we have both on the commercial side and on the defense side. So if you absolutely -- and I think Larry said it at our Investor Day, and he said, hey, if M&A was banned, he wouldn't lose any sleep over it. And I think everybody in the company kind of shares that view that we feel very good, and there's no like driver that we have to go do something.

There are a couple of places like we did the small acquisition called Innoveering on the defense side. It has accelerated our journey into a lot of classified programs into hypersonics. So it is taking probably a couple of years off our development cycle. So we'll keep looking at things that make strategic sense, that make operational sense, that make financial sense, but we are at peace with ourselves, right? So no rush to do anything here.

Joshua Pokrzywinski

Understood. Maybe just pivoting over to Vernova, and I want to start first on Renewables. Obviously, big profit improvement expected over the next couple of years, and IRA certainly has a lot to do with that. But just to remind folks or maybe update folks if there is anything to add, how much of the improvement you expect over the next few years is really a function of this kind of distinguished volume price environment versus some of the work you've done on productivity or restructuring or selectivity in the portfolio? I suspect those are kind of the bigger buckets. But maybe give us any kind of walk that would help spell that out.

Rahul Ghai

Yeah. So if you -- let's just spend a minute on onshore and then grid. I mean if you look at between the two businesses, again, going from $1.5 billion or so of losses last year to breakeven this year in onshore and grid. I think we've said previously, we're expecting low double-digit plus kind of margins. So -- and the improvement is coming from three areas. One, working through the warranty issues that we kind of found out last year, right? Obviously, lack of those warranty reserves is helping us this year.

The second is huge improvement in cost takeout. I gave you one example at the outset on what we're doing on the outages side in power, there are similar actions like that. I mean when I walk the floor with Vic the other day on what he's doing on onshore wind, I mean, the projects are astounding, right? He's done such a good job on just driving Lean and operating rhythm into everything that he does both in the manufacturing area and then out in the field as well. And if you look at the headcount in that business, that headcount is down 30% year-over-year. So a big part of the improvement over the next few years is going to be just coming down that cost curve, both in the field and in SG&A. So that's the second piece of improvement.

And the third is going to come from just the selectivity of projects that the team is picking up. So if you look at our backlog margin, the backlog margins are kind of in the low double-digit range now, so which is a huge change from where we were. So all those pieces add up. We work through our warranty issues. We've taken the reserve. We feel good about that. We're burning through the warranty issues that are outstanding. We keep working the cost side, and then through selectivity of projects that drives improvement in backlog margins, which shows up in the P&L.

And then on the grid side, as I'm learning the business, you learn the fact is that we're probably going through a generational improvement in the grid infrastructure in the U.S. Some of the projects that the team was talking about, I mean, those grids have not been updated for 60 years. So there's a huge demand out there that should help as well. So that is what turns this thing around. And offshore, obviously, we need to work through our projects in the early stages of that.

Joshua Pokrzywinski

Understood. And I guess maybe the playbook of that, if there is an analogy, is what you guys did in Gas Power equipment. Obviously, a very squeaky wheel several years ago. Clearly, a lot of improvement has been made. But how do you think about balancing things like share and profitability now? I mean I think the view on where that market stabilizes is much clearer today than it used to be. But even though that's a focused sort of services business, how should we think about the interest in growing the installed base, growing share in things like large frame?

Rahul Ghai

Yeah. So if you think about our share in power, I mean, maybe a quarter across the world. If you remove China, we have probably a third, and the share is stable. We're the market leaders there in power outside of China. So it's -- we're in a really good spot. The share is stable. And I think we are -- clearly, profitability is more important than share. We want to -- if we want incremental volume, we want incremental volume that is profitable and it's profitable. Specifically, I think Scott and team are focused more on the OE profitability for the projects upfront. So that is clearly the focus there and not just you choosing share numbers. And then that OE profitability over time translates into both the services profitability as well. So that's the focus.

Joshua Pokrzywinski

Understood. And then I think what's been a nice story maybe underneath the surface in Gas Power equipment is the strength that you guys have seen in aero derivatives sort of pairs nicely with what you do in Renewables. How long does that last? Does that accelerate as onshore deliveries ramp up? How should we think about that relationship perhaps over the next few years?

Rahul Ghai

Yeah. So on the aero derivatives, again, I'm learning the business here, but what I've learned is that it is a really nice complement to the Renewables cycles. And it is a competitive differentiator for us because our competitors do not have the same capability that we do there. So that's a really good thing for us. And as you grow the Renewable infrastructure, the intermittency of the power supply increases. And having aero derivatives helps with that quick start, the backup power, making sure the grid fluctuates, a grid operates at a stable level, and the Renewables kick in when they're needed. So it's a really nice complement.

So we do expect that business to continue to grow as the Renewables infrastructure increases. And right now, again, going back to supply chain, that product is one that we are constrained on supply chain. So we are not able to meet the demand. So that should help, and it's a profitable piece for Scott and team. So as we as you go into '24 and '25 and the supply chain constraints ease, that should be a nice lift to the business.

Joshua Pokrzywinski

Understood. And then maybe to tap into another sort of item that was a bigger legacy concern several years ago and has been nicely derisked is on the insurance side. As that has gotten derisked and you get the benefit of things like higher interest rates, how do you think about that long-term relationship? Is there -- have we reached this point where maybe it's safer to look elsewhere, jettison? Or is it derisked enough to where you truly can run it off internally?

Rahul Ghai

Yeah. So on insurance, listen, first, Larry and the rest of the team has done a really good job putting really good operators in place, right? So that business is far more stable today than it was. So in terms of managing risk, driving premium increases where it makes sense. So all that, operationally, it's in a much, much better place than it was a few years ago. We expect the last payment to go in on insurance in first quarter of next year. It's up to $1.8 billion.

So that goes in and after that, we think we fully funded the liabilities on insurance. We don't expect any incremental contributions. So now in terms of -- to your question, we'll keep looking at options, but it is -- whether it's the whole, whether it's the part. So that is definitely -- we will keep looking at things, but there is not an imminent solution to that problem. So it's on the table, but we'll keep working it, but not imminent.

Joshua Pokrzywinski

Excellent. And I see we're coming up on time, but I do have one more question. Just as we approach separation, anything that we should be watching for or anything that you're cognizant of on the timing front or any kind of milestones that we should be aware of?

Rahul Ghai

No, I think as I said at the opening, everything is on track here. I mean the businesses are performing as expected in '23, if not better than where we were back in March, right? Things have improved since then, 2024 looks good. So businesses are stable, improving. The balance sheet capacity has improved with everything that we are doing. Legal entity separation is on track. So we are -- everything looks good for early 2024.

Joshua Pokrzywinski

Excellent. Rahul, I see we're out of time. Thank you for the time. Appreciate it. I enjoyed the conversation.

Rahul Ghai

Thank you so much for having us. Yes. Thank you.

Joshua Pokrzywinski

Thank you.