It has been a while since General Electric (NYSE:GE) has had a good year, but that is exactly what 2019 has been for the industrial conglomerate. Year-to-date, GE stock is up a whopping 60%, marking the stock’s first up year since 2016 and its best year since 1982.
Why the breakout rally in GE stock in 2019?
Signs have emerged that the company’s multi-year turnaround plan is finally starting to bear some fruit. That is, the company has shed non-core businesses and assets, and is using those proceeds to deleverage the debt-heavy balance sheet. At the same time, the company’s remaining core businesses are starting to stabilize amid improving external and internal conditions. Operating costs are coming out of the system, and margins and cash flow are improving.
The fundamentals are getting better, and so GE stock is running higher. But can the red-hot rally in General Electric stock continue?
I think so. For three big reasons.
First, management is doing everything right, and it appears that 2020 and 2021 will be a continuation of the recovery that started in 2019. Second, the global operating backdrop is improving, and this improvement should provide a nice boost to GE’s numbers in 2020/21. Third, the valuation remains sensible, and the numbers pave a realistic pathway for GE stock to hit $14 within the next ~12 months.
The Optics Are Improving
The first big reason to stick with the rally in GE stock is because everything is pointing to this idea that 2020 and 2021 will be better than 2019.
Fiscal 2019 was the first year for new CEO Larry Culp. In his first year, Culp has done exactly what you would expect him to do with a struggling company, and that is shake things up. He has shed non-core businesses and sold non-core assets. He has used a bunch of money to pay down debt, aggressively looked for cost-cutting opportunities across the portfolio, hyper-focused resources on certain core businesses, and cut the dividend.
In other words, Culp’s first year as CEO has come with a ton of changes. All those changes created a lot of noise, and only some of them yielded immediate benefits.
In 2020 and 2021, though, the pace of big changes will slow. All of this noise will fade. As it does, the big changes that were made in 2019, will start to yield tangible benefits in 2020 and 2021, such as revenue stabilization, margin improvements and profit growth.
Amid these favorable optics of a struggling industrial conglomerate getting its groove back, GE stock should grind higher.
The Fundamental Backdrop Is Improving
The second big reason to stick with the rally in GE stock is because the fundamental backdrop supporting General Electric’s business is improving.
Specifically, General Electric is a major player in the global manufacturing economy. When that economy is firing on all cylinders, General Electric’s businesses tend to perform better. When that economy is struggling, General Electric’s businesses tend to fare worse.
Since January 2018, the global manufacturing economy has been in a downward spiral, as escalating trade tensions have weighed on business confidence and activity. But, over the past few months, trade tensions have eased globally, business confidence/activity has rebounded, and the manufacturing economy has picked up some steam.
Just look at Purchasing Managers Index data from across the globe. The global PMI has been rebounding in a convincing and steady way since mid-2019.
Historically speaking, such rebounds are not short-lived. As such, it is reasonable to expect this rebound to persist. The fundamentals support this logic, too, since it is likely that trade tensions continue to de-escalate in 2020.
Broadly, then, manufacturing economic activity should improve in 2020, and that should provide healthy tailwinds for GE stock.
General Electric Stock Remains Cheap
The third big reason to stick with the rally in GE stock is because shares remain relatively cheap, and the numbers imply healthy upside potential.
General Electric’s revenues should stabilize over the next few years, amid investments into the core businesses as well as re-accelerated activity in the manufacturing economy. At the same time, margins should run higher thanks to cost-cutting measures. This combination of revenue stabilization and margin improvement should drive healthy profit growth over the next few years.
GE stock simply isn’t priced for this reality. Street estimates peg General Electric’s earnings per share at 85 cents by fiscal 2021. That seems entirely doable to me, under assumptions of revenue stabilization and margin improvement. Based on an industrial sector-average 16- to 17-times forward earnings multiple, that implies a fiscal 2020 price target for General Electric stock of $14.
That is about 25% higher than where shares trade hands today, meaning that GE stock still has plenty of room to move higher.
Bottom Line on GE Stock
GE stock is having its best year since 1982. While 2020 and 2021 won’t be this good, they should still be good years for General Electric, characterized by macro-economic improvements, revenue stabilization, margin expansion, debt reduction and healthy profit growth. Meanwhile, General Electric stock remains sensibly valued considering that growth is coming back into the picture.
The investment implication? Stick with the rally in GE stock for now.
As of this writing, Luke Lango was long GE.
