When the market weakens and selling picks up, speculative stocks tend to pull back as investors shy away from companies with an uncertain outlook. General Electric (NYSE: GE) tried, on many occasions since February, to hold the $10 level. But the S&P 500 index lost 5,9% in May, pulling GE stock down to $9.43 to close the month. What will it take for GE shares to return to the $10 level and move up from there?
General Electric is in a multi-year turnaround, so investors cannot expect the company shedding assets fast enough to lower its debt/equity below 3x. Finding buyers who will buy its non-core assets will take time. The transformation will build on GE’s already-strong global installed base where customers demand technology and service solutions and products.
In the short-term, management should have no problem with improving operational efficiency. What will GE cut to lower costs?
At the governance level, the company will have a smaller and more focused board for 2019. With a smaller team, GE will have fewer layers of management and may more easily track and measure accountability. On a day-to-day basis, GE will continue to improve its financial position. The more debt it cuts, the less interest it needs to pay.
GE’s Diversified Portfolio
Aviation, Power, and Healthcare are three of General Electric’s biggest revenue generators, at $30.3 billion, $27.3 billion and $19.8 billion, respectively. Renewable Energy brings in $9.5 billion in revenue. The bad news is that revenue from the Power unit will slip in 2019 but grow in 2020. Free cash flow will fall again this year after falling $2 billion in 2018. Profit from the Gas unit fell short due to project execution and legacy underwriting. The good news is that the contract services book is healthy. The company aims to improve transnational services profitability.
General Electric’s 2019 Outlook Reaffirmed
GE forecast free cash flow from negative $2 billion to break-even, with positive FCF in 2020 and acceleration in 2021. Margins will not change this year, which suggests that costs are stabilizing relative to the falling revenue. Earnings per share will be in the range of 50-60 cents, which implies GE’s forward P/E is at least 15.8x.
Asset Sales Show Contribution
The sale of BioPharma will close in Q4/2019 and will bring in $20 billion+ in cash proceeds. The transportation merger delivered $2.9 billion in cash and a 24.9% ownership in Wabtec. The overall result is GE running with a higher cash balance. Industrial cash balance topped $17 billion while GE Capital’s liquidity was $15 billion.
If GE could strengthen its business sooner than markets expect, the stock would trade well above the $10 level. At the $13 level, the stock’s forward P/E would be over 20x, which is a possibility in a year’s time. Already, GE’s Power unit is starting to enjoy order profiles at a higher margin. And its Gas Power base costs are falling compared to last year’s levels. GE has recently won more turbine orders for new gas-fired power plants than its competitors. It booked six orders for its HA-class turbines. That added to three orders in the first quarter.
Aviation will continue performing well, especially with strong engine utilization and price increases. Engineering costs are also trending with top-line growth, which should sustain profit margins.
Risks All Around
GE’s turbine wins are impressive but if it bid the lowest, this will put pressure on the Power unit’s performance. The unit does not have to win deals if it results in losses. The U.S.-China trade war is a macroeconomic headwind for industrials and could force the company to lower not only 2019’s outlook but also its 2020 and 2021 targets.
The 15 analysts who cover General Electric stock have a price target of $11.18, according to TipRanks. This is in-line with my $10-$13 price target. If investors assume the company has a perpetuity growth rate of 3%-4%, a DCF model would imply the stock’s fair value is $12.40.
Key Takeaway on GE Stock
GE stock may trade in a range in the next few months as markets wait for the company to carry out its multi-year turnaround plan. The shares appear less risky as debt levels fall through asset sales and cash flow grows as business improves.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.