You can’t say General Electric Company (NYSE:GE) hasn’t tried to reverse the long decline in the GE stock price. As news has become worse and worse, the company has at least tried.
After all, it finally made a CEO change in July, just weeks after former CEO Jeffrey Immelt topped our list of CEOs who needed to go. In its Q3 earnings report, the company tried to get ahead of the weakness in GE stock by slashing guidance and resetting investor expectations. And on Monday, new CEO John Flannery tried to calm investors with a detailed Investor Update, in which the company highlighted its strengths and laid out plans to address its weakness.
It wasn’t enough, or even close. GE stock fell another 7% after the update, which was headlined by a 50% cut in the GE dividend. The GE stock price now sits at its lowest level in over five years.
The weakness isn’t a buying opportunity. The GE stock price isn’t cheap, based on 2018 earnings-per-share guidance, and it’s downright expensive when looking at free cash flow. And while GE laid out ambitious goals going forward, it’s far from certain those goals will be achieved.
GE Stock: Investor Update
There was plenty of news in the investor update, much of it on the negative side. As noted, the big news was a cut in the GE dividend from $0.96 annually to $0.48. The cut was no surprise — year-to-date, free cash flow actually is negative, and GE still has $136 billion in debt. In fact, James Brumley predicted a cut on this site just last month.
The halving of the payout cuts GE’s yield to a far less attractive 2.3%. It’s worth noting that until recently, a 3% yield generally provided support for GE stock — that figure now would imply a share price of $16, another 16% downside from Monday’s close.
But guidance for 2018 looks concerning as well. GE now expects 2017 adjusted EPS to come in at $1.04-$1.12. The 2018 figure is expected to decline, to just $1.00-$1.07. Just three months ago, Street consensus for 2018 EPS was $1.70. Those projections now have come down 40%; GE stock has fallen 24% over the period, which implies more downside could be on the way.
The core problem with GE stock at the moment is that it might be cheaper, but it’s not cheap. The stock still trades at 18x+ the midpoint of 2018 EPS guidance. More concerning, it trades at over 28x free cash flow guidance, based on numbers from the investor update presentation. Investors are still pricing in a rebound in General Electric earnings and cash flow, even though the company itself isn’t seeing that rebound coming until 2019, at the earliest.
Some Good GE News
All that said, there was some good news in the update. GE highlighted the strength in the Aviation business, which now generates ~35% of earnings. Demand is extremely healthy, as seen in the 68% gains in Boeing Co (NYSE:BA) stock so far this year. The company is guiding for 7-10% organic growth and 200-300 bps in margin expansion in the segment next year.
$3 billion-plus in cost is expected to come out of the business next year. General Electric called its struggling power business “fixable,” with cost cuts and lower capacity coming in the near future. The company plans to sell $20 billion in assets, improving the balance sheet in the process.
It’s a standard turnaround story, buoyed by the fact that, as the company pointed out, 40% of the management team has turned over since June. Those managers are getting new pay packages as well, with a greater emphasis on equity and performance.
With that plan, GE believes it can get back to organic revenue growth, buoyed by strength in Aviation and improvements in businesses like Healthcare, Power, and Transportation. Baker Hughes, a GE company Class A (NYSE:BHGE) is expected to contribute to growth as well. Cost savings will help margins, and as a result, GE margins should expand, driving earnings growth. Cash flow conversion is guided to improve in concert, driving increases in that metric as well.
But there’s two problems with investors buying that argument.
Bottom Line on General Electric
The first problem is that some level of rebound is still priced in at 18x forward earnings. That’s a similar multiple to rival Honeywell International Inc. (NYSE:HON), which has outperformed GE for years. International Business Machines Corp. (NYSE:IBM), an interesting analogue to GE stock, trades at 11x, a multiple that actually looks intriguing.
The second problem is that while GE laid out its plan for improvement, it clearly didn’t convince the market that the plan would work. New management might be helpful, but Immelt’s reputation aside, it’s too easy to blame management solely for recent weakness.
Transportation demand is likely going to stay well below early-decade peaks, barring a huge spike in oil prices. Price competition in the Renewables business isn’t going anywhere. Power will take years to fix, and the Alstom acquisition has been a failure. There’s a lot going on here that isn’t just a matter of cutting costs and changing managers. General Electric needs real change, and years of it. Until the market starts pricing those efforts in, and the risk inherent in those efforts, the GE stock price won’t be cheap enough.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.