The shares of General Electric (NYSE:GE) are holding steady around $11. With CEO Larry Culp’s turnaround in motion, investors are more confident in the conglomerate’s future prospects. But don’t expect GE to have smooth sailing going forward.
GE has a long way to go before it is back on track. The phrase “a lot of moving parts” may be a corporate lingo cliche. Yet in the case of GE, it’s a pretty apt description.
Key to the turnaround are unwinding GE Capital, fixing GE’s unprofitable business lines (like GE Power), and divesting non-core assets. But given GE’s exposure to factors outside its control, those objectives could be challenging. For example, take GE’s Aircraft Engine business. GE Aviation is one of the company’s flagship assets. However, Boeing’s (NYSE:BA) 737 MAX debacle could indirectly impact GE’s Aviation business.
Add in GE’s turnaround issues, and it’s clear that the company is going to have a bumpy ride. What does that mean for the stock in 2020? Fasten your seat belts, and let’s dive in!
The 737 MAX Issues Are Another Hiccup on the Road to a Turnaround
Earlier this year, Boeing’s 737 MAX jets were grounded due to several deadly crashes. In December, Boeing suspended production of its 737 MAX jet. Why is Boeing’s problem now GE Aviation’s issue? GE Aviation (in partnership with Safran) supplies engines for the 737 MAX.
Aerospace parts manufacturers receive most of their payments when planes are delivered. In other words, if the production of the 737 MAX planes is halted, it could be awhile before GE Aviation gets paid. The company estimates that $1.4 billion of its revenue could be tied up due to this issue.
For GE’s bears, this is fuel for the fire. JPMorgan analyst Stephen Tusa pointed out that Boeing represents 70% of GE Aviation’s engine business. Unlike analysts who are bullish on GE Aviation, Tusa says it is not a strong business.
But the 737 MAX headwind may not be a long-term issue. William Blair’s Nicholas Heymann believes airlines could resume flying the 737 MAX planes as soon as four months from now.
Throughout December, GE’s shares have held steady. That could mean investors have not fully priced in the risk posed by GE stock.
On the other hand, GE’s so-so performance this month contrasts with the stock market’s new highs. Perhaps this “stuck-in-neutral” performance is the market’s way of pricing in uncertainty.
With or without the risks posed by the 737 MAX, General Electric is not going to fix itself within a year. Even the analysts who are bullish on GE estimate the company’s earnings won’t jump until at least 2022. Given the valuation of the stock is not way below that of its peers, earnings improvements, not multiple expansion, is the key to significantly moving GE’s share price.
It May Take Years for GE to Move the Needle
For FY20, analysts, on average, are calling for earnings per share of 68 cents, or a forward price-earnings (P/E) ratio of 16.5. Peers like Honeywell (NYSE:HON) and United Technologies (NYSE:UTX) have forward P/Es of 20.1 and 17.3, respectively. That means General Electric could have some runway for multiple expansion, but not much.
UBS’s Markus Mittermaier estimates GE could generate EPS of $1 by 2022, and he sees GE trading at $17 per share at that point. Based on the forward P/E ratios of GE and its peers, I think GE could shoot up to $20 if its EPS reaches $1 within the next two years.
That could make General Electric a great medium-term opportunity. It’s not a quick trade, but it could compound nicely if you buy it and hold it for years.
But it’s definitely no slam dunk or the shares would not have such a high risk premium. A lot could happen in the next two years.
Unemployment is at record lows, and the stock indices are at record highs. But everything could change on a dime. If we finally get our overdue recession, GE will have a tough time generating $1 of EPS in two years.
There are also other land mines GE has to navigate. As I discussed in my prior analysis, General Electric has a massive pension shortfall. It also has material potential liabilities from its long-term-care insurance business.
There’s Plenty of Time to Buy General Electric Stock
Larry Culp was tapped to be GE’s CEO mainly because of his success at Danaher (NYSE:DHR). Culp’s management skills helped Danaher’s unique operations strategy succeed. Acquiring industrial businesses, improving their profitability, and parlaying that cash into new deals, Danaher is a conglomerate that’s tuned in to shareholder value.
At GE, Culp could pursue a more Danaher-esque scenario down the road. For now, he needs to get GE’s house in order. The recent 737 MAX issue is but a mere hiccup along the road of the turnaround.
As investors are taking a “wait-and-see” approach before bidding General Electric higher, there’s plenty of time to purchase the shares. But keep an eye on the macro picture before putting in a buy order.
As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.