Rating Action:
Moody's affirms ratings of GE and GE Capital at A2; outlook remains negative
26 Jun 2018
New York, June 26, 2018 -- Moody's Investors Service ("Moody's") affirmed the ratings of General Electric Company ("GE"), including the A2 senior unsecured rating and the P-1 short term rating. Concurrently, Moody's also affirmed the ratings of GE Capital Global Holdings, LLC ("GE Capital") and its subsidiaries, including the A2 long-term issuer rating of GE Capital. The outlook of the ratings of GE, GE Capital and its subsidiaries is negative. These rating actions follow the announcement by GE of its plans to separate its healthcare business ("GE Healthcare"), likely to be completed sometime in 2019.
RATINGS RATIONALE
Moody's views GE's plan to separate the GE Healthcare business and its 62.5% ownership in Baker Hughes, a GE company ("BHGE"), as a net credit positive, and a key driver behind the affirmation of the company's ratings. In Moody's view, there was urgency for GE to achieve substantial improvements in financial condition, in particular to generate the amount of cash flow expected for an enterprise of its breadth. As such, Moody's anticipated that the company would need material changes to its business portfolio. The planned separation of GE Healthcare would be the most significant move to date, and follow closely on the planned sale of GE Transportation to Westinghouse Air Brake Technologies Corp., and other asset divestitures.
Absent such actions, a profile consistent with the A2 rating would be unlikely given expected market conditions and GE performance. Once completed, these asset separations would result in a portfolio of fewer but more focused businesses. GE would have the opportunity to further streamline corporate expenses, while optimizing synergies in sales and engineering. Also, as the plan contemplates a $25 billion reduction in debt, it would result in a meaningful step towards deleveraging GE. The lower debt would offset the reduced revenue diversity as well as the loss of earnings and cash flow attributable to this unit while demonstrating the company's commitment to de-risking its capital structure. As well, the planned separation of GE's investment in BHGE over the next two to three years can potentially provide significant additional capital for further debt reduction or investments.
GE's strong implicit and explicit support of GE Capital, including through debt guarantees and provision of borrowing capacity on an unconditional and irrevocable basis, results in Moody's equalization of GE Capital's senior unsecured rating with the senior unsecured rating of GE.
Nonetheless, the ratings outlook remains negative as continued weakness in earnings and cash flows are expected through 2019 and into 2020. GE's largest segment, Power, has endured a prolonged period of demand weakness in gas turbine demand, which is expected to continue for several years, constraining growth in margins and cash flows in this segment for some time. As well, only modest growth is anticipated for GE's much smaller Renewable Energy segment, with segment operating margins expected to remain at or near 7%. GE's Aviation segment, while highly profitable with segment operating margins of over 24%, is not currently generating robust cash flow due to a ramp up of investments in new engine platforms, and is not expected to do so before 2020.
As a result, GE's free cash flow (excluding BHGE), which was substantially negative in 2017 and Q1 2018, is not expected to surpass $2 billion annually over the next few years despite a significant reduction in dividends starting this year. Likewise, EBITA margins are only expected to be in the 11-12% range through 2019, lagging historical GE averages and below the mid- to upper-teens levels typical among A2 rated diversified industrial companies. As well, debt to EBITDA, currently at nearly 4 times, compares unfavorably to other industrial companies at the same rating level.
A ratings upgrade is unlikely given the current weakness in earnings and cash flow, and change to a stable outlook would require a return to revenue growth and margin improvement in GE's Power segment, and the resumption of strong free cash flow generated by both the Power and Aviation businesses. Through 2019, clear evidence of consolidated EBITA margins progressing towards levels sustainably above 15% with free cash flow consistently above $3 billion would be important factors supporting a stable outlook. As well, the commitment of the company to appropriately deploy proceeds from the sale or separation of businesses, while maintaining conservative financial policies will also be important towards a stable outlook. Moody's expectations that debt to EBITDA will approximate 2.5 times pro forma for the GE Healthcare separation and debt reduction in 2020, with identifiable prospects for further deleveraging thereafter, would be necessary for a stable outlook.
GE's ratings could be downgraded if Moody's anticipates GE is not on a steady trajectory of improving cash flow, return on asset and profits, even before the GE Healthcare unit is separated. Specifically, lower ratings could be considered with EBITA margins remaining in the low- to mid-teens, retained cash flow to net debt of less than 20%, or debt to EBITDA that is expected to remain above 2.5 times. Ratings could be lowered if the company experiences difficulty in executing planned portfolio actions or cost restructuring initiatives. As well, the inability to maintain sufficient resources at GE Capital, including in the form of assets that can be divested, to meet the planned capital infusions into the insurance business, could also cause a ratings downgrade. Once GE Healthcare is separated, given the loss of diversification of business and the cash flows associated with GE Healthcare, the ratings could be pressured down absent expectations of EBITA margins in the mid teens level, with free cash flow well over $3 billion and improving financial leverage.
GE Capital's ratings could be upgraded if GE's ratings are upgraded and if GE's support of GE Capital, including of future debt issuance, remains strong. A downgrade of GE Capital's ratings could result from a weakening of GE's support or weaker than anticipated support of future debt issuance. GE Capital's standalone credit profile could improve if the company strengthens its ratio of tangible common equity to tangible managed assets towards levels comparable to those of finance and leasing company peers and meaningfully reduces its insurance exposures. Conversely, GE Capital's standalone credit profile could be lowered if liquidity or the operating performance of GE Capital's aircraft leasing business weakens materially, or if other events meaningfully reduce the firm's capital position.
