Things have not been great for General Electric (NYSE:GE) and a negative report by Harry Markopolos was the last thing GE stock needed.
When I last wrote on GE, I had opined that investors should remain on the sidelines. I also opined that GE should spin-off its aviation segment to create further value.
I maintain my “remain on sidelines” view on GE stock even after a sharp decline of 20% in August, recent developments only have solidified my position.
Harry Markopolos Versus General Electric
Markopolos is a well-known whistleblower related to exposing Bernie Madoff’s Ponzi scheme.
In a detailed report, Markopolos claimed that GE is under-reporting $38 billion in losses. That’s a big accusation considering the company’s current market capitalization of $77 billion.
However, GE was quick to respond to the allegations with the company calling them “meritless.” In an interview with CNBC, Leslie Seidman, an independent director, commented that the claims were “misleading, inaccurate and inflammatory.”
It is worth noting that Leslie was a former chairman of financial accounting standards and according to her view, the report by Markopolos is “full of opinions.”
However, there is an important point mentioned by Leslie in the interview that backs my view of staying on the sidelines.
GE will go through an annual loss recognition test in the third quarter. Further, GE will also complete the annual statutory cash flow testing in the first quarter of 2020. According to GE press release –
It is the statutory cash flow testing, not GAAP accounting, that determines the funding requirements for all insurance companies.
I believe that the market will wait for liquidity cues from these tests and the stock can potentially remain sideways. Further clarity on the liquidity position or additional liquidation requirement for LTC insurance can dictate the stock direction.
Additionally, GE has planned to monetize assets and the markets will wait for announcement on that front for additional liquidity cushion.
Therefore, even if the claims by Mr. Markopolos are baseless, General Electric stock is unlikely to witness any bullish momentum as markets are in a “wait and watch” mode.
Economic Headwinds Will Keep GE Stock Depressed
The Federal Reserve has already cut interest rates for the first time since the end of 2015. This is clearly an indication of the fact that economic growth is decelerating.
There is a fear that a possible recession will be “long than deep.” If this holds true, General Electric is likely to face challenging times.
It is also a matter of concern from the perspective of asset monetization. With General Electric looking to ramp-up cash position, a slowdown or recession will make asset sale challenging.
To add to the woes, General Electric CEO has already stated in March that free cash flow from the industrial and power unit will remain negative in 2019. Even if this factor is already discounted in the stock, it is a strong reason to avoid GE.
Moreover, the power segment is unlikely to see positive free cash flows for the coming years and offsets potential positives from other segments. This is another reason why it makes sense to spin-off robust cash flow divisions to unlock shareholder value.
Spin-offs will also make room for detailed reporting of segment or business segments. This is something investors will be looking for, amidst fraud allegations.
Final Words on GE Stock
General Electric still has a long road ahead in terms of restructuring, asset sale and deleveraging. Economic headwinds will make the path challenging and possibly delay asset monetization. Further, the power business remains a drag and impacts the consolidated free cash flows.
The coming quarters will be important as GE releases the awaited reports on the annual loss recognition test and annual statutory cash flow testing.
Overall, GE stock has a mountain to climb and I expect sideways movement amidst volatility than any sharp upside in the coming quarters.
In-sync with this view, investors should stay on the sidelines and wait for further clarity on the liquidity profile and business restructuring developments.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.