Shareholders may want a microscope strong enough to view the dust particles that settle on this company’s earnings report for the quarter.
The report, due out in less than 48 hours, is supposed to unearth a truer picture of how much income General Electric Co. (GE, Financial) made from its long-term contracts.
There’s a new accounting standard for contracts on Wall Street and GE says it’s complying. For many years, the industrial conglomerate had an accounting standard that basically determined early on that the company would be paid “in full” for multiyear contracts. Even if the company got stiffed over time, its books showed payment “in full.”
But now, GE Chairman and CEO John Flannery has widely shared that he welcomes the change, which has prompted a restatement of earnings for years 2016 and 2017. Flannery and Chief Financial Officer Jamie Miller are expected to release the information as part of first-quarter earnings on Friday.
It’s anybody’s guess what the earnings report will disclose to investors, but it is more than likely the market will react to the new information. A consensus of several estimates from analysts is forecasting earnings of 11 cents per share.
For his part, Flannery, who took charge last summer, is trying to spread a message of transparency and openness after years of opaqueness and fuzzy financials.
Earlier this year, GE announced plans to replenish reserves for its legacy reinsurance program. The company said the fund was in need of financial assistance because people are living longer and need more nursing and care. It announced plans to yank $6.2 billion in an after-tax charge and a $3 billion cash contribution to cover its obligation.
In the fourth quarter, the Massachusetts-based company reported an earnings loss of $1.13 per share, after reporting gains of 39 cents per share a year ago.
GuruFocus, which amasses 30 years of company fundamentals for S&P 500 companies and other publicly traded entities, shows dramatic swings in the company’s net income and free cash flows.
Net income in 2017 was reported as a loss of $6 billion. The prior year, the company showed a gain of $8 billion.
In free cash flow, it reported $2.5 billion in 2017 after reporting a loss in free cash flow of $8.1 billion in 2016, GuruFocus data showed. In 2015, it reported almost $12 billion in free cash flow.
The massive swings have drawn the attention of the Securities and Exchange Commission, which is investigating the accounting of contract assets.
The company said it doesn’t see any issue with the investigation.
GE’s long-term contracts
The restatements were outlined in a regulatory filing dated April 13. The amendments will have no impact on cash flow from customer contracts, but will diminish the company’s retained earnings.
GE said it will report a loss of 17 cents per share on reported (diluted) earnings loss of 68 cents per share for 2017. For 2016, it will report a loss of 13 cents per share on reported earnings of $1 per share. In total, that will reduce earnings by roughly 30 cents per share over the two-year period.
The company also made reductions as part of a reinstatement of revenues and earnings from continuing operations, the filing showed.
In 2017, for example, the company reported a net earnings loss from continuing operations of $9.86 billion. The restated amount reflected is now $11 billion. In 2016, it reported a gain of $9.49 billion and the restated amount is $8.16 billion, the filing showed.
In revenues, the company reported $122 billion in 2017. The restated amount is $118 billion, the filing showed.
Reuters reported on Friday that the company was taking a $4.24 billion equity charge over the last two years.
GE’s restatement documents also reflect adjustments to standards related to pensions, cash flows and income taxes.
Officials say the adjustments will not have an impact on first-quarter results, but the new standards will be used to reflect earnings going forward.
Why new accounting standards for long-term contracts
The new standard on contracts was implemented to make sure that a company’s cash flow more closely resembles income that is received.
Alexander Lowry, a former executive at JPMorgan Chase & Co. (JPM), who is a finance professor at a northeast college, said the change makes for better business practices.
“The new accounting standard offers more transparency into how a company estimates revenue from long-term contracts,’’ said Lowry, the executive director for the master of science in financial analysis at Gordon College.
“GE will recognize revenue over time for its long-term service agreements,” Lowry said. “The change will better align revenue to actual work done throughout the life of the contract. Before this change, GE’s accounting did not build in the possibility of a contract getting canceled. The company previously assessed contract cancellations as remote possibilities and therefore, the full revenue recognition did not pose a problem.”
‘Out’ at least for now
Some guru investors abandoned the stock before GE’s first-quarter earnings could be discerned.
Steven Romick (Trades, Portfolio) sold out of his holdings, based on filings dated March 31. In the fourth quarter, the guru owned 7.6 million shares and sold out for an average price of $15.54 a share. Records show he had a total estimated loss of 16% since he first began buying shares in 2015.
Other gurus moved to reduce holdings in the early months of the year.
The T Rowe Price Equity Income Fund (Trades, Portfolio) reduced its holdings by 11%, bringing its current exposure to 6.1 million shares. T Rowe has been gradually removing itself from the investment. In the third quarter of 2014, it purchased up to 31.5 million shares for an average price of $26.
In the last selloff, in the first quarter of the year, T Rowe Price sold for an average price of $15.54 a share. The investment has produced an estimated loss of 2%.
In the final months of the year, David Herro (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio) bailed out of the stock. But a number of gurus opened positions. New buyers included Steven Cohen (Trades, Portfolio), Tom Russo (Trades, Portfolio), Mason Hawkins (Trades, Portfolio) and Louis Moore Bacon (Trades, Portfolio).
Anybody’s guess
Whether GE is a good buy is often a point of controversy.
The Peter Lynch chart suggests its current trading price of $13.68 a share is still above fair market value. The median is about $12 a share.
In five years, the company saw its market cap dive to $118.79 billion from $282 billion. That’s a 58% drop.
In Wednesday afternoon trading, GE stood at $13.68 a share, down 0.8%. Its 52-week range is $12.73 to $30.54 a share.
GuruFocus rates the conglomerate 4 out of 10 in financial strength and 6 out of 10 in profitability and growth. The financial ratings are as of Dec. 31.
In earnings before interest, taxes, depreciation and amortization, GE posted 14 cents a share in December 2017. A year before that, it had posted EBITDA of $2.09 a share.
The company reported revenue of $122 billion in 2017, flat from the prior year. It has seen gross profits diminish to $30 billion in 2017 from $97 billion in 2008. Its operating margins have tightened. In 2017, it reported 9.73% compared to almost 30% in 2007. Net income in 2017 was reported as a loss of $6 billion. The prior year, the company showed a gain of $8 billion.
In long-term debt, it faces $111 billion versus $337 billion in 2005.
A general skepticism
Some industry watchers and others fear GE will face more challenges.
“I don’t think the worst is over yet,’’ said Lowry, the finance professor.
On Friday’s earnings call, he said he believes management will give direction on the safety of the company’s dividend and its future plans for asset sales.
GE has a dividend growth rate of 4.2% over five years. Its dividend yield of 5.24% is at the top of its peers. The mean is closer to 1.57%
GE began asset sales this month. Just a few weeks ago, it announced it was selling its health care technology unit for $1.05 billion in cash to a private equity firm. The company has a wide array of businesses, including health care, aerospace and energy.
