General Electric (NYSE:GE) is in the middle of a financial turnaround. If its projections come true this year, GE stock will be trading for just 15 times earnings. At the high end of EPS projections by the company, 65 cents per share, the stock would be selling for just 12.8 times earnings.
In terms of its net debt-to-EBITDA targets, GE has a long way to go, despite some recent debt reduction actions. The company needs to clearly present its progress in attaining its turnaround targets to investors.
The Wall Street Journal’s recent article described how CEO Larry Culp, plans on fixing GE. He wants to make it like Berkshire Hathaway. A few staff at headquarters would run strategy and capital allocation.
He seems to be making progress. So far he has cut debt, sold off companies and plans on lowering net debt on the industrial side to just 2.5 times EBITDA.
The Q2 earnings presentation said that free cash flow would now be in a range of negative $1 billion to positive $1 billion for the year. Previously the guidance was for negative $2 billion to $0 free cash flow. He has a long way to go.
For example, GE has a $78 billion market value. If GE reaches the $1 billion level in free cash flow that would give GE stock to a 1.38% free cash flow yield. That is still very low for a company this size. The ratio should be at least 4 to 5 times higher.
Recent Activities to Restructure Debt
Culp is acting on his plan to further reduce debt. On Sept. 12, GE announced it would receive $2.7 billion from lowering its stake in Baker Hughes (NYSE:BHGE) to just 38.4% from 50.1% and a further $300 million from related securities.
Next, GE said it would buy back up to $5 billion of its debt using those proceeds. This is part of the plan to reduce net debt to GE’s target to less than 2.5 times EBITDA.
On Oct. 7, GE said it would freeze its U.S. pension obligations for about 20,000 salaried employees. These moves would reduce its pension deficit by approximately $5 to $8 billion and net debt by $4 to $6 billion.
In total these two moves will reduce its debt between $9 and $11 billion. GE now says it is on track to hit its <2.5x Debt-to-EBITDA target by the end of 2020, at current interest rates.
GE Is Making Progress
There is has been no effect on the GE stock price from these announcements. Maybe one reason is that investors cannot easily track what GE is doing to what it is targeting.
Here is a simple example. Nowhere in the GE second-quarter report does GE report its EBITDA number. It also does not report its full net debt figure. The related slide presentation does not show these numbers as well.
So here is my estimate of EBITDA. Net income was -$126 million from continuing operations in Q2. Adding back interest expense of $991 million, preferred dividends of $188 million and taxes (a benefit) of -$148 million, brings the running total to $905 million.
GE’s press release for Q2 earnings does not include the cash flow statement. This is very odd for such a large company. The investor has to go to the SEC website to download the 10-Q to find out what GE’s cash flow looks like.
The Q2 10-Q filing, on page 46, shows that depreciation and amortization were $2,480 million for the six months period for tangible assets and $916 million for intangibles. So now we have to deduct the first-quarter numbers to derive the most recent quarterly depreciation and amortization figures.
The Q1 10-Q filing, on page 44, shows that those numbers are $1,126 million, and zero for intangibles. Therefore the Q2 total depreciation and amortization figure is $2,270 million.
Net Debt-to-EBITDA Ratio Estimate
My best estimate of EBITDA in Q2 is as follows: $944 million, plus $2,270 million, or a total of $3,214 million. Now looking at the 10-Q filing for the Q2 balance sheet, the estimated net debt is:
- $15,933 million in short term debt, plus $90,233 million in long-term debt, plus $4,180 million in operating lease liabilities, plus $36,840 million in insurance liabilities, less
- $34,905 million in cash and $38,275 million in investment securities.
- Total Net Debt: $74,006 million
Estimated annual EBITDA: $12,856 million (i.e. $3,214 million x 4)
So the Net Debt-to-EBITDA ratio now is 5.75x (i.e. $74 billion / $12.9 billion). This is a long way away from the <2.5 ratio target number that GE is forecasting by the end of 2020.
The Bottom Line on GE Stock
This means that given the present EBITDA number, GE’s net debt has to fall to $32.14 billion from $74 billion. That is a reduction of $41.866 billion or a 56.6% drop from Q2 levels. GE’s recent moves account for $11 billion of this reduction.
GE still needs to reduce debt by $30 billion or increase EBITDA by a portion of that number.
Note again, it shouldn’t be so hard for the regular investor to figure this out. That may be why Culp recently replaced the CFO.
GE stock has not moved with its recent announcements. GE stock will eventually recognize the turnaround efforts by Culp. But he has a long way to go. This includes taking actions that convince investors his targets will be reached and in presenting them clearly to investors.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks, which includes both dividend and buyback yields. In addition, subscribers a two-week free trial.