Investors seem torn between letting go of shares of General Electric (NYSE: GE) stock or holding it in the hopes of recovering some of their losses.
While in the short-term the rebound of GE stock could fade, one thing is certain: the conglomerate is in the midst of a turnaround. More importantly, this rebound will take multiple years. GE’s CEO, Larry Culp, will need to first sell off its non-core businesses and lower the company’s debt, and then turn his focus towards growing its business.
Culp always said that the company’s biggest strength is its team that is ready to win. It has a valuable customer installed base in a number of businesses that can grow going forward.
GE has 70,000 engines, over 7,000 gas turbines, and over 40,000 wind turbines in the market. To grow its existing businesses , GE must leverage its strong franchises to capture a bigger market share.
The big point of emphasis for those who are bearish on General Electric stock is GE’s weak balance sheet.
Major Challenges Ahead
GE’s debt is putting a strain on its balance sheet. Its cash flow faces headwinds due to the problems of GE Capital. Restructuring is expensive, and GE’s pension commitments loom. Its Power division, which sells gas turbines in the 25-30 GW range, faces excess capacity.
GE has agreed to sell all or parts of its Transportation, Baker Hughes, and BioPharma units. BioPharma will bring in around $20 billion, BHGE $12 billion, and transportation $6 billion. That totals $38 billion in cash that GE can use to pay down debt.
GE Capital had $66 billion in debt in 2018. Conversely, the unit had $15 billion in cash.
The company’s Power unit is often in the news because of its quality issues, so GE must repair this business. At a conference, GE identified three reasons for Power’s underperformance. First, the unit was slow to recognize and adapt to market realities. Second, it had non-operational headwinds and debts that it had to pay off. Third, weak management of the unit in the last few years caused its results to be weak.
The owners of General Electric stock have hoped the other units will counter Power’s weakness. Given the strength in the aviation and aerospace market, the results of GE’s aviation unit should continue to be strong.
GE has a goal of lowering the net debt/EBITDA ratio of its industrial businesses to under 2.5. In 2018, GE’s industrial units had a net debt of $55 billion. The closing of the BioPharma sale by the end of this year, plus the sale of Baker Hughes, will help GE get to that favorable debt/equity level.
GE forecast that the free-cash flow of its industrial units would be positive by next year. Investors, who bid General Electric stock to over $11 after the company announced the $21 billion Biopharma unit sale to Danaher (NYSE:DHR), had hoped the unit’s FCF would be positive sooner.
Potential Catalysts for General Electric Stock
What are the potential positive drivers of GE stock besides asset sales? Stronger performances from healthcare and aviation could give investors some encouragement. GE management forecast a meaningful improvement in FCF in 2020-2021 due to strength from its renewables, aviation, and healthcare, businesses, along with the positive impact of its restructuring initiatives.
The Valuation of General Electric Stock
GE stock has traded near the $10 mark since February. The trading volume of General Electric stock has declined in recent weeks, even though the company has been more open about its challenges and outlook. Most notably, Culp acknowledged its multiple issues, but General Electric stock still didn’t drop much below $10.
The Bottom Line on General Electric Stock
GE stock is not for everyone. Value investors looking for a quick turnaround play should buy something else. But patient investors with a time frame of at least two or three years may want to start a position in GE stock at its current levels. If Culp can repeat the success he had in turning around Danaher, then General Electric stock will be higher in a few years.
As of this writing, the author did not hold a position in any of the aforementioned securities.