General Electric (NYSE:GE) stock has been trying hard to regain lost glory. In the recent past, the company has been involved in asset sales, spinoffs and mergers. The objective is to strengthen GE’s financial position and focus on core growth businesses.
In February 2019, the company completed the spinoff and merger of its Transportation business. The company also announced the sale of its BioPharma business to Danaher for approximately $21.4 billion.
As a result of these developments, General Electric stock has recovered by 54% from December 2018 lows and currently trades at $10.55.
However, I believe that General Electric needs another spinoff to create greater shareholder value.
GE Aviation is my focus and I believe that the segment spinoff will translate into value unlocking for shareholders. Further, GE Aviation, as an independent entity, will attract more investor interest.
GE Aviation Valuation
After a 54% upside since December 2018, the General Electric stock currently trades at a market capitalization of $89 billion.
Back in 2018, Jeff Sprague, an analyst at Vertical Research Partners, pegged the SOTP valuation for the aviation business at $85 billion. JPMorgan analyst, Stephen Tusa, has been bearish on the stock. However, the analyst still assumes a valuation of $60 billion for the aviation business.
There are others who believe that GE Aviation is valued at $100 billion. Overall, ballpark estimates might imply that GE Aviation is valued in the range of $60 to $80 billion. GE Aviation, as a separate entity, would therefore create more value.
Clear Revenue Visibility
For the year ended December 2018, GE Aviation reported revenue of $30.6 billion. Further, as of June 2019, the company’s engine and services backlog was $209 billion. This implies revenue visibility of 6.83 years based on 2018 annual revenue.
Importantly, the aviation business delivered free cash flow of $4.2 billion on revenue of $30.6 billion. An order backlog of $209 billion would imply free cash flow estimate of $25 to $30 billion. This underscores my point that the aviation business would be valued in the range of $60 billion, at least, to $100 billion, at most.
General Electric expects free cash flow from aviation to remain flat in 2019 and 2020 as compared to 2018. However, there is free cash flow growth visibility in 2021 and beyond.
GE Aviation has witnessed strong order inflow in the recent past and this makes me bullish on the growth prospects. The order intake at the Paris air show was $55 billion. The Air Asia and CFM order is valued at $23.1 billion. The deal with Qatar Airways is valued at $5 billion. The order intakes have been in June and July.
For GE Aviation, almost 38% of the order backlog is from China, Asia Pacific and Latin America. These are typically high-growth regions and I expect order inflow to remain robust from these regions.
GE Power Remains a Drag
For General Electric, one of the major concern that sustains is the performance of the power business. With weak demand for gas turbines, the power segment can potentially continue to under perform.
The power segment reported negative free cash flow of $2.7 billion in 2018. The company expects negative free cash flows for 2019 and 2020 with forecast of positive free cash flow in 2021. However, JPMorgan’s Stephen Tusa is of the opinion that free cash flow is unlikely to be positive until 2023.
Therefore, in a bear cash scenario, the power segment is likely to remain a drag for the next 3-4 years. According to RBC analyst, General Electric is likely to pursue sale of business within the power segment.
I believe that further business divestiture within the power segment will be positive as it enhances the company’s cash level and discards the under performing units. It can imply that positive free cash flow is seen well before the next 3-4 years.
Bottom Line on General Electric Stock
General Electric stock has paused after a 54% rally from December 2018 lows. I believe that there needs to be a strong catalyst for the next leg of GE stock’s rally. That catalyst should come in the form of value-unlocked spinoffs. Further, divestiture within the power segment and improvement in company wide free cash flows can also trigger upside in the stock.
From a risk perspective, it is also worth noting that the global economy has slowed down with 2019 economic growth likely to be the weakest in three years. This will impact the oil & gas segment of GE’s business negatively.
Overall, it makes sense to remain on the sidelines before fresh exposure to General Electric stock. While the company has made progress in terms of organizational restructuring and liquidity cushion, more shareholder value creation avenues need to be explored.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.