General Electric Had a Triumphant 2019 as Turnaround Takes Flight

You haven't missed the fun yet, GE's comeback is still in the early innings

General Electric (NYSE:GE) has been one of the year’s hottest stocks. Up 50% year-to-date and even more off last year’s lows, General Electric has finally started to recover from rock bottom. For awhile, it seemed like GE couldn’t stop producing more bad news and asset write-downs.

GE stock
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But the tide definitively turned this fall. That’s when a dubious negative report helped highlight that GE’s bears had run out of ammunition. Now General Electric is on the cusp of generating free cash flow again, and is set to deliver sizable earnings per share in 2020. And the good news isn’t stopping yet.

Here’s why General Electric can continue to advance next year.

General Electric Is Defying the Odds

Investing legend Warren Buffett laid down a stark warning about buying stock in turnaround situations. Back in 1979, Buffett offered up wisdom when he wrote:

“Both our operating and investment experience cause us to conclude that ‘turnarounds’ seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price.”

Many folks, myself included, were skeptical about General Electric’s ability to execute such a rarely successful turn. Buffett’s axiom is generally true, and for most investors, it was easier to buy a good, solid industrial company rather than take a gamble on GE being able to recover.

I came up against this myself. I called General Electric a “buy” back in September following the controversial Harry Markopolos short-seller report. But I didn’t actually purchase any stock, figuring there were more conservative ways to make a buck. And I missed out on the subsequent gains.

That’s because CEO Larry Culp has done a fantastic job righting the ship at General Electric. Culp was a rock star CEO at Danaher (NYSE:DHR) and he clearly hasn’t lost his magic touch. And for investors wondering if it’s too late to get on board with General Electric, I’d argue it’s actually safer to buy the stock now than it was six or nine months ago.

A Clean Bill of Health

In a funny way, the 175 page short-seller report was a big positive for General Electric. That’s because all the potential short-seller allegations and bearish arguments got aired out in the open. It put an end to all the innuendo and rumors; now everyone, bull and bear, long and short, knows both sides of the argument.

Against that backdrop, Culp went to the public and to the analysts, and explained how the short-sellers were misguided. Arguably the balance sheet is the most important concern. And Culp has taken decisive action there, reducing the company’s net debt (excluding the capital division) substantially. It was around $55 billion last year, and should be down to roughly half that by the end of next year. General Electric sold its biopharma division to Danaher for more than $20 billion. That made a huge dent in the debt burden. On top of that, it has raised capital selling of part of its stake in Baker Hughes (NYSE:BKR) and unloading the transportation unit into Wabtec.

Undoubtedly, these moves have hurt General Electric in the short run, both in terms of profits and prestige. But they have helped ensure GE’s long-term viability. In addition to paying down tens of billions in debt, General Electric has been able to shore up the pension plan and put GE Capital on firmer footing.

As a result of all this, few people are seriously talking about GE going bust anymore. Within just months of Markopolos’ incendiary report, the conversation has gone from potential fraud and bankruptcy to GE merely being overvalued. That’s a huge win for Culp and his company.

GE Isn’t Overvalued, It’s Under-Earning

Sure, it’s easy to make the argument that General Electric is too expensive now. The company is looking at making something like 60 cents of earnings and producing $1 billion in free cash flow next year. This would mean that GE trades for nearly 19x forward earnings and a huge multiple of its free cash flow.

However, that form of analysis misses the potential here. Both GE Power and its renewables division are earning far short of their normalized profits. Culp is restructuring these divisions to get them back to where they should be. Power alone is burning around $3 billion a year. That’s a gigantic number. Remember that GE is at about $1 billion in positive free cash flow annually now. Just get the power division to break even and GE’s cash flow roughly quadruples. For earnings, getting power and renewables back to mild profitability, let alone normal profitability, should boost earnings by at least 20%, significantly improving the company’s price-to-earnings ratio.

Can Culp pull off the transformation and fix these struggling assets? Only time will tell. But he delivered incredible results at Danaher. And so far, he’s made the right moves at GE. His timely insider stock purchase right after Markopolos’ negative report was a particularly astute step to build confidence.

The Bottom Line on General Electric

Not everyone is convinced that the coast is clear for General Electric heading into 2020. Longtime GE critic Stephen Tusa, a JPMorgan analyst, reiterated his $5 price target recently. While he acknowledged that General Electric has given off the appearance of a turnaround, he says things are worse than they look under the surface. Tusa wrote that the most recent positive earnings results hold just “small fraction of meaning when it comes to forward fundamentals,” and that GE is “missing guidance on core business [ongoing earnings] that was set in March.”

So GE still has some skeptics. But hardly anyone is talking about crisis or bankruptcy anymore. General Electric has moved the conversation from wipe-out risk to how long it will take to get underperforming units heading in the right direction again. That’s a huge transformation.

Yet GE’s share price is still down nearly two-thirds from what investors paid for it a couple of years ago. With GE already advancing past the crisis stage, the turnaround is well under way. There’s much more clarity around the company following the short-seller reports and worst-case scenarios are now off the table. As such, this is a great time to take a position in General Electric if you’ve been on the sidelines.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2019/12/general-electric-good-2019-turnaround-underway/.

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