General Electric’s (NYSE:GE) most recent quarterly earnings report quickly sent the stock close to its 52-week highs. GE stock is at a level not seen since October 2018.
At $11.55, the stock rebounded 29% in the last month and is up a whopping 80% from 52-week lows. What did GE report in its latest quarter that changed investor sentiment for the better?
On Oct. 30, General Electric stock rallied from $9 to $10.50 after the company reported progress in its multi-year turnaround. It is still early in the transformation but forecasts meaningfully better evidence of a recovery in 2020 and 2021.
The Renewables segment offers potential revenue ahead. The IEA forecast the renewables segment could be a $1 trillion opportunity over the next few decades. GE needs to first deliver better profitability.
In the third quarter, GE’s margins fell 500 basis points year-over-year to 2%. It needs its cost productivity programs progressing favorably first.
At Renewable Energy, GE delivered ~1,400 turbines and repower kits in Q3. International orders are strengthening and order pricing is improving. After earning its first commercial deployment in Cypress, investors may grow accustomed to GE winning similarly sized deals in the future.
Free Cash Flow Headwinds
GE reported $4.4 billion in working capital headwinds in its free cash flow YTD. This included $2 billion in inventory build from renewables, aviation, and Healthcare.
In Q4, this will shift as GE ships products. Plus, the $2.4 billion in receivables YTD is due largely to the 737 MAX. So, if Boeing (NYSE:BA) gets the plane certified in the Dec. or Jan. 2020 timeframe, that should reverse GE’s FCF headwinds.
The company is seeing strength in cash flow from the Aviation division. Helped by the Aviation aftermarket and services, steady cash flow should continue into 2020. And again, if the MAX orders resume sometime next year, GE stock could continue its rebound.
In Q3, Aviation orders fell by 4% to $8.8 billion. Equipment orders fell 27%, hurt by lower commercial engine orders that fell 54%. LEAP engine orders fell by 90%.
Service orders increased 15% and GE ended the quarter with a backlog at $253 billion, up 4% sequentially and 20% year-over-year.
Business Stabilization
The drag on results from Power may come to an end soon. On the earnings call, GE said that it saw signs of stabilization due to better project discipline and execution.
At gas power organic, revenue rose 3% after GE reached a major milestone of 100 HA turbine orders in the quarter. It cut fixed costs by 9% YTD, matching business activities with the realities of the market.
Margins at Healthcare are not that exciting. But this segment is still a potential growth market for GE. Healthcare revenue was $17 billion and if GE can increase margins through productivity growth, the unit will not hurt overall performance. To get there, GE must carefully invest its savings back into the business.
The Bottom Line on GE Stock
GE will continue restructuring to drive costs lower. From there, it will examine the better opportunities and put more effort into good projects.
In the long run, profit margins should improve and cash flow should increase. Assuming a discount rate of 8% and a perpetuity growth rate of 2% in a 5-year DCF growth exit model, General Electric stock is undervalued. Its fair value is around $15. Conversely, investors may think the stock should have a higher discount rate of 10%.
This would price in unforeseen delays in the business turnaround. In this case, GE stock trades close to its fair value of around $11.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
