The departure of CEO Jeffrey Immelt from General Electric Company (NYSE:GE) came as no surprise. Last month, we here at InvestorPlace suggested 10 CEOs likely to follow Ford Motor Company’s (NYSE:F) Mark Fields out the door — and Immelt was No. 1 on our list.
Investors cheered the move, as GE stock gained 3.6% on the news. One key reason: that 3.6% gain was roughly four years’ worth of returns on GE stock (including the GE dividend) under Immelt’s tenure.
The question, as always, in the markets is: what now? The answer to that question isn’t notably different post-Immelt. Incoming CEO John Flannery will have some options, and a breakup a la 1980s-era AT&T Inc. (NYSE:T) isn’t off the table, either.
But, the core of GE isn’t changed by new management, nor is it necessarily changed by new strategies. This remains an old-line, low-growth industrial business. The merger of GE and Baker Hughes Incorporated (NYSE:BHI) gives some growth potential in oil field services and equipment — and some added risk if the resurgent shale boom again recedes.
But, GE stock still isn’t cheap, given its growth prospects, and the GE dividend appears at some risk for a cut. Flannery may bring fresh eyes to the CEO spot. But, expecting a material change in General Electric stock as a result looks far too optimistic.
A Lack of Growth Has Weighed on GE Stock
The recent problem for GE has been a relative lack of growth. In 2016, organic revenue growth in the industrial businesses was basically zero. Adjusted operating profit grew 2% on the same basis. In 2015, GE grew operating profit 10% on an adjusted, organic basis, but revenue that year, too, was flat.
The numbers looked a bit better in Q1, though not enough to change the long-term outlook for the company or for GE stock. A previous target of $2 in 2018 EPS has all but officially been abandoned, and likely will be under Flannery. (Only one of 15 analysts believes General Electric will reach that level in EPS next year.)
With GE stock trading at $29, it thus doesn’t look particularly cheap. Analyst estimates suggest a 15x+ multiple to 2018 EPS. For a cyclical company with limited profit growth (most of the company’s EPS growth has been driven by share buybacks, not net income increases), that multiple hardly seems out of line.
Can Flannery Drive Growth for General Electric?
The CEO change doesn’t necessarily fix this problem. That said, there is some potential optimism that GE’s growth rates can move upward. The headwind from lower locomotive sales the Transportation segment is diminishing as that business drops to ~4% of overall sales. The BHI merger will help the Oil & Gas division, which has struggled. GE Lighting, meanwhile, is up for sale.
At the same time, GE Power is growing, and the still-small Renewable Energy business increased 44% last year and another 22% in Q1. Aviation and Healthcare are growing, no small feat in relatively stagnant markets. With O&G reinforced (hopefully) by Baker Hughes, the bigger parts of GE’s businesses look reasonably healthy.
It would be ironic, indeed, if GE finally got unwound only after Immelt left. After all, he executed the literally hundreds of deals that changed GE dramatically from what it was when he took over in 2001. With some of the larger businesses performing well, and hopes for a larger digital/industrial convergence still bright, GE might be able to drive growth needed to get earnings to $2 — eventually — and create growth expectations that are enough to drive multiple expansion as well.
Something like 18-19x $2 EPS would value GE stock around $37, for instance, or 25%+ upside. Even if that takes another 2-3 years, when combined with the 3%+ yield offered by GE stock, it would make GE intriguing at current levels.
There are several problems with that scenario, however. The first is that a version of that case has existed for GE stock for years. But, so far, the stock has underperformed. Rival Honeywell International Inc. (NYSE:HON) has posted better growth and far better shareholder returns. Assuming a continued expansion of the economic cycle, that may be the case going forward as well.
The second is that even that hypothetical return just isn’t very impressive. 10%+ per year, including dividends, is fine as far as it goes, particularly for a large-cap stock. But, it also belies the argument that Flannery can somehow drive major upside in GE stock.
In fact, I’m skeptical that there’s really all that much a new CEO can, or will, do at this point. As noted, the major businesses are performing reasonably well. GE Lighting will be sold, most likely, but there aren’t any other spin-off or sale possibilities left. It makes little sense to sell Transportation at this point. The other businesses are performing well, and removing them from the overarching digital strategy seems unwise before that strategy plays out.
The broader point here is that I don’t see much change in the case for GE stock under a new CEO. For all the criticism of Immelt, he did take over at a difficult time, and spent a good chunk of his tenure trying to unwind the impact of GE Capital.
That work largely is done, for better or for worse, and it leaves little left in the way of major changes remaining. Improved execution and a better focus on margins might help General Electric, and GE stock, somewhat. But, investors expecting miracles, or huge upside, under John Flannery are likely to be disappointed.
As of this writing, Vince Martin held no position in any of the aforementioned securities.