Business Breakdowns
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And just on the backlog point, I understand it's a smaller percentage of revenue relative to services, but can you contextualize what backlog looks like now and maybe how that compares to history, and whatever framing that you think would be most effective? [00:00:00] S1: Absolutely. And the backlog is one of the more interesting underpinnings of GE's five- to ten-year outlook. Their current backlog is something like $175 billion on a headline basis; that's four and a half years-ish of revenues. But underneath that, there are a few nuances. So if you strip out just the commercial backlog, which obviously is the majority of the business, that's closer to six years. And within that, if you take out just the services element of revenues, which obviously is the key profit pool that GE Aerospace enjoys, that's closer to seven years. So we have a very unusually long backlog and visibility for GE. And to put it in context, this is not unusual in the supply chain. If you look at the airframers themselves, both Airbus and Boeing, with their current production rates, they are running at close to a decade's worth of backlog. So very strong visibility throughout the OE as well as the engine ecosystem. [00:00:00] S0: And relative to, let's say, five years ago, ten years ago, do those numbers in terms of four times current revenue, ten years of backlog for the airframers—is that meaningfully higher, lower, or in line with where they've been historically?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And relative to, let's say, five years ago, ten years ago, do those numbers in terms of four times current revenue, ten years of backlog for the airframers—is that meaningfully higher, lower, or in line with where they've been historically? [00:00:00] S1: I would say they're moderately higher than historical averages, but not substantially so. Aerospace generally has very long-term cycles, and that allows these companies to have significant backlogs and visibility in terms of how these engines are produced, because they need to tie in with the airframers in terms of their production. They're very closely knit in the supply chain. And secondly, because of the increasing prevalence of long-term service agreements, that has also ticked up in terms of how much the backlog gives you the visibility for. [00:00:00] S0: And for a business like GE, I can hear essentially—again, I'll use the simple numbers—somewhere in four to five times revenue in terms of backlog. So four years' worth looking out. Is that lumpy in terms of seeing major realization of backlog two years out, but maybe you have a slow year next year? Does the lumpiness drive anything, or is it realized pretty evenly over the course of those four years?
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: And for a business like GE, I can hear essentially—again, I'll use the simple numbers—somewhere in four to five times revenue in terms of backlog. So four years' worth looking out. Is that lumpy in terms of seeing major realization of backlog two years out, but maybe you have a slow year next year? Does the lumpiness drive anything, or is it realized pretty evenly over the course of those four years? [00:00:00] S1: That's a good question. On the services side of things, which is something like 70% of the backlog, you should see a fairly predictable, steady evolution of the burn rate, so to speak, of the backlog converting into revenues. On the OE side, that is somewhat lumpier, because that sort of ties into production rates at Boeing and Airbus. And if there are any issues in terms of either the supply chain or their production run rates, you will see some lumpiness. But given that both Boeing—since the sort of issues they've had in the last few years, it's been fixed—and Airbus have been on a pretty good rhythm, I would say both the OE and the services backlog today seem well positioned to have a fairly steady cadence over the next five to ten years. This is outside of things like pandemics and recessions, so to speak. So on a run-rate, normalized basis, we should be able to see a fairly steady growth of that revenue and earnings.
· Matt Reustle
[00:00:00] S0: Yeah, and calendar years, quarters shouldn't matter as much as they do sometimes in the markets. Many times investors will see through, but it's interesting to note and to hear nonetheless. Maybe we could do a revisit to the GE pure-play story. We captured it to some extent in the previous episode, but it's played out even more. We don't have to spend too much time on the origin stories of GE—we can hit on that. I want to talk a little bit about Larry Culp in particular and some of the moves that he's made. Do your best to just outline some of the key milestones and things that really were done that moved the Titanic around when it was struggling for so long.
· Ramesh Narayanaswamy
[00:00:00] S1: GE goes back more than 100 years. It's a company that dates back to none other than Thomas Edison. For most of the previous couple of decades, GE was probably the very definition of a conglomerate, with a very diverse portfolio of businesses operating in industrials, in healthcare, and in financial services. But if you look at business history, there are very few things as reliable as a cycle of conglomeration and then deconglomeration. And under the time of Jack Welch and Jeff Immelt, their eras were defined by a focus on growth, on market share through acquisitions, and what I would call earnings-per-share management. A big part was played by GE Capital, which exposed a lot of leverage in the system, and the various businesses housed under GE were competing for capital, and there was no true business rationale for holding them together. Now all of that changed with the arrival of Larry Culp, who was really the first outsider CEO at GE. Culp was on the board at GE during the brief tenure of John Flannery, and he took over as CEO in October 2018. Now Culp, for those who follow industrials businesses, is a very well-known and proven operator and capital allocator, and had a fantastic performance—both operationally and stock price–wise—at Danaher, where he was CEO from 2000/2001 to circa 2014. So if GE needed to deconglomerate, then Larry Culp was the perfect choice.
· Matt Reustle, Ramesh Narayanaswamy
[00:00:00] S0: Maybe you can detail some of the steps that he took in that deconglomeration. It goes beyond that in terms of how the operational execution has played out. What would you point to? Because I think the track record from Danaher was there to point to, but he certainly followed through with some of the execution on the GE side. [00:00:00] S1: In simple terms, I would say Larry brought the Kaizen-like lean manufacturing principles that he was so successful in implementing at Danaher to GE. To use a Japanese phrase, he walked the Gemba, as they call it: go to the place where the value is being added—the manufacturing floor, the shop floor—and really focus on very basic ideas of continuous improvement, problem-solving, and, more importantly, addressing the “don't shoot the messenger” culture, which was badly needed at GE, and also, crucially, focusing on the customer. I think I've heard Larry describe his philosophy as “common sense vigorously applied,” which is probably a good phrasing of what he did at GE. And for GE in particular, that meant simplification and deconglomeration and focus. So he spun off the healthcare assets as GE Healthcare, the power businesses as GE Vernova, focused on debt reduction, and what we are left with is just the aerospace assets. [00:00:00] S0: What do you think led him to sticking with the aerospace assets versus going with healthcare or Vernova? It's just an interesting choice. It might have just been market size, but do you think there's anything there in terms of what led him to continue on with this specific business line?