INVESTMENT THESIS
BUY rating on General Electric Co. (NYSE: GE). That’s a long way off.
RECENT DEVELOPMENTS
Over the past year, they have underperformed, rising 2% while the broad market is up 18%. Over the past five years, the shares have lost more than 60% of their value, while the Dow Jones Industrial Average – of which GE is no longer a component – has increased 73%. The beta on the stock is 1.05.
In addition to earnings, the Street is also watching the company’s cash flow generation. Prior to the pandemic, GE CEO Larry Culp had forecast GE Industrial free cash flow of $2-$4 billion for 2020, though management withdrew that guidance after releasing 1Q results. Due to the pandemic, as well as the grounding of the Boeing 737 MAX Jet, GE Industrial adjusted free cash flow for the first nine months was negative $3.7 billion. During the 3Q earnings call, CEO Culp said he expected the company’s Industrial free cash flow to be at least $2.5 billion in the fourth quarter and positive in 2021. In a December 8 press release, CEO Culp reiterated his FCF forecast, and also indicated that he expected positive FCF in 2021.
GE also continues to reduce leverage. Earlier this month, it voluntarily prefunded $2.5 billion of estimated minimum ERISA GE pension plan funding requirements for 2021, 2022, and into 2023, and repaid $1.5 billion of its intercompany loan to GE Capital. These actions reduced GE’s pension deficit by $2.5 billion and further simplified its financial structure. Including these announced actions and scheduled maturities in the fourth quarter, GE will reduce debt by approximately $14.5 billion in 2020 – including $9.6 billion in GE Industrial debt and $4.9 billion in GE Capital debt. This will bring total debt reduction to approximately $28 billion since the beginning of 2019.
The company’s targeted financial goals include achieving a sustainable credit rating in the single-A range (currently BBB+), generating an Industrial net debt/EBITDA ratio of less than 2.5, and increasing the dividend payout in line with industry peers over time.
EARNINGS & GROWTH ANALYSIS
GE breaks its operations into the following segments: Power (19% of sales), Aviation (27%), Healthcare (26%), Renewable Energy (25%), and GE Capital.
FINANCIAL STRENGTH & DIVIDEND
GE pays a dividend, which it cut twice in 2018. The current quarterly rate is $0.01. Management has indicated that it is targeting a dividend payout in line with peers over time.
The company has a share buyback program, but has slowed repurchases to conserve cash.
MANAGEMENT & RISKS
(NYSE: DHR: BUY). CEO Culp replaced John Flannery in October 2018. Mr. Flannery had served in the roles for approximately a year after taking over from longtime CEO Jeffrey Immelt. Mr. Flannery was unable to brake the company’s downfall as a U.S. industrial icon. During his tenure, the company cut the dividend and embarked on a restructuring plan that included the potential divestiture of its crown jewel Healthcare division.
New CEO Culp had a successful run at the much smaller Danaher. The company, which Mr. Culp led from 2001 to 2014, has a 27-year track record of generating more free cash flow than net income on an annual basis. Danaher has been a model of consistency over the years: mid-single-digit revenue growth, margin improvement and share buybacks have resulted in double-digit EPS growth. Danaher has deployed a growth-by-acquisition strategy and has an exemplary record of integrating acquired companies.
Investors in GE shares face risks, ranging from macroeconomic factors such as global growth and currency trends, to more micro issues such as M&A integration risk and capital requirements. We note that GE has been cooperating with the staff of the SEC on its investigation of legacy matters related to long-term service agreements, GE Capital’s run-off insurance operations, and the goodwill impairment charge in 2018 related to GE’s Power business. GE has recorded a reserve of $100 million as of September 30, 2020, related to the investigation in its entirety, encompassing all matters under investigation.
COMPANY DESCRIPTION
General Electric is classified as a diversified industrial business. The company has 205,000 employees.
VALUATION
After forming a double-bottom at $6.70-$6.90 in late 2018, the trajectory had turned positive. However, the stock retested that double-bottom in September and October 2020.
On December 9, BUY-rated GE closed at $11.39, up $0.43.
Source: Argus
