Why investors should welcome GE selling a steam power business

According to reports, General Electric (EG 1.72%) is about to sell its nuclear turbine business to the French French Electricity (EDF) (ECIFY -2.54%) for $1.2 billion. It looks like a relatively small transaction on the periphery of GE’s industrial empire, but its potential importance should not be underestimated. If a deal does materialize, GE investors have reason to be optimistic. Here’s why.

Image source: Getty Images.

Why Power Matters

You have to go back to GE CEO Larry Culp’s 2021 investor presentations for some more context here. The discussion of free cash flow (FCF) and earnings at the Alliance Bernstein event in early June is fascinating. During the chat, Culp mentioned the possibility of reaching $7 billion in FCF by 2023.

His argument assumed that $10 billion in operating profit ($11 billion in operating profit from the industrial sector) produced $7 billion in FCF after deducting interest, taxes and capital expenditures. The table below summarizes Culp’s comments on segment earnings and provides figures for recent years.

GE’s industrial segment

Commentary on 2023 Segment Profit (in billions of dollars)

2020

2019

2018

Power

“call it $1-2 billion in operating profit”

$274 million

$291 million

($1,015 million)

Renewable energy

“positive”

($715 million)

($791 million)

$140 million

Aviation

“$6 in Aviation”

$1,229 million

$6,812 million

$6,454 million

Health care

“call it $3.5, take the midpoint of health”

$3,060 million*

$3,737 million

$3,522 million

Data source: GE presentations.

It’s no secret that a recovery in commercial aviation – and with it a recovery in GE Aviation engine and engine sales – is key to its recovery. However, note that the largest improvement profits will come from the energy segment outside of aviation. As such, it is a key factor in business prospects.

GE power

The segment manages four separate businesses organized within the company’s power and power portfolio (GE Hitachi Nuclear, Power Conversion and Steam Power). Gas Power sells gas turbine equipment and services and contributed $12.7 billion to the power sector’s $17.6 billion revenue in 2020.

In general, management is making good progress in restoring profitability and FCF in the gas-fired power business. For example, on the second quarter earnings call, Culp noted that “we’re probably going to do better than that single-digit revenue guide that we’ve been talking about for services” when discussing growth guidance. higher-margin services from Gas Power. .

A gas turbine.

Image source: Getty Images.

The remaining $4.9 billion of GE Power’s revenue in 2020 came from the Power portfolio, including $3.7 billion from Steam Power. This is where EDF’s potential deal becomes relevant.

GE is exiting the coal business and its stated plan is to redirect revenue from steam to higher-margin utilities and nuclear businesses. The following table shows the indications given during the March Investor Outlook. GE selling its nuclear turbine business (steam turbines used in nuclear power plants) would leave the steam power generation business primarily a steam utility business. This is good news, as management believes that Steam Services would have a high single-digit FCF margin.

Indeed, on the latest earnings call, Chief Financial Officer Carolina Dybeck Happe asked what the Steam Services margin could be in 2023. She replied, “Services margins are expected to still be strong, and we expect that that they are strong, probably slightly less than those of gas.”

Thus, the sale of the nuclear business (steam turbines) would leave steam power (and the power portfolio) as a high-digit FCF services business. With the Gas Power business picking up (which is expected to have a high single-digit profit margin in 2021 alone), GE Power would be well positioned to meet Culp’s target of $1-2 billion in profit. operation by 2023.

Steam Power Revenue Composition

2023East

2021East

2020

Services

65%

60%

55%

Nuclear

30%

ten%

8%

Coal

“minimal”

30%

37%

Data source: GE presentations.

A turning point

The sale of the business would also mark an important step in GE’s transformation since Culp took over. GE acquired the company with its ill-fated purchase of Alstom’s French energy assets, and a sale would represent GE unwinding from a deal that has haunted the company since the ink dried.

The company manufactures the Arabelle steam turbine, used in a third of the nuclear power plants in the world, including EDF Energy. It is therefore logical that EDF is trying to acquire it as part of a vertical integration game, especially since the factory that manufactures the Arabelle is in France.

What this means for GE investors

A deal would make sense for GE’s investors and help the company accelerate its trajectory to $7 billion in FCF in 2023. It would also allow GE Power’s management to focus on its world-class turbine business and to increase its higher-margin service revenue within this. This could make it much easier for GE to meet its mid-term FCF targets.

Lee Samaha has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.