Deleveraging Could Trigger Further Upside for GE Stock

Debt reduction and sustained growth in aviation sector are positives

General Electric (NYSE:GE) stock failed to break out above $10 convincingly several times in the last year. However, in the last few months, sentiment related to GE stock have changed and the stock currently trades at $12.85. That’s 68% higher from August 2019 lows of $7.65.

Deleveraging Could Trigger Further Upside for GE Stock
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Citigroup analyst Andrew Kaplowitz rightly explains the reason for upside as General Electric having “begun the process of re-establishing credibility.” Andrew Kaplowitz has also raised the stock price target from $14 to $16. That implies further upside of 25% from current levels.

John Inch, analyst at Gordon Haskett, has been a long-time bear on GE stock. Even he upgraded GE to “neutral” from “sell.” John raised the price target to $11 from an earlier target of $7.

Clearly, General Electric is starting to restore confidence of investors and analysts. I believe that positive developments are likely to continue in the coming quarters.

From a technical perspective, GE stock is likely to see strong support in the range of $10 to $11. The stock might witness some profit booking after a strong rally since August 2019. I believe that $10 to $12 is a broad accumulation range for the stock.

Deleveraging Will Continue in 2020

One of the reasons for GE stock moving higher is the roadmap for deleveraging. For GE Industrial, net-debt-to-EBITDA for fiscal year 2018 was 4.8 and it has declined to 4.2 in FY2019. Leverage will decline further in 2020 and GE is targeting net-debt-to-EBITDA of 2.5 towards the end of 2020. I see that as very likely.

Recently, South Korean regulatory authorities approved the $21.4 billion acquisition of General Electric’s bio-Pharma division by Danaher Corporation (NYSE:DHR). The proceeds from the sale will be used for deleveraging.

General Electric also has 38.4% stake in Baker Hughes (NYSE:BKR). Considering the current stock price of Baker Hughes, it would translate into proceeds of $8.7 billion. In addition to these transactions, General Electric is also considering the sale of its steam power division.

Therefore, the year 2020 is likely to be associated with significant reduction in debt and sale of non-core businesses. As the organization turns leaner and simpler, the markets are likely to react positively.

Aviation Segment Will Continue to Grow

The aviation segment is one of the key cash flow drivers for GE. In FY2019, the company reported aviation revenue of $32.9 billion, which was higher by 8% as compared to FY2018. Importantly, the segment profit was at $6.8 billion with a profit margin of 20.7%.

For the fourth quarter of 2019, the segment also reported an order intake of $10.7 billion. This implies an annualized order intake of $42.8 billion. Therefore, with a robust order backlog, the segment will continue to contribute to free cash flows.

A potential headwind for the segment in 2020 is the timing of 737 Max returning to service. Randy Tinseth, vice president of commercial marketing at Boeing (NYSE:BA) believes that 737 Max will be back by mid-2020. If this holds true, GE stock is likely to react positively.

On the valuation of GE aviation, analyst estimate are in the range of $30 billion to $100 billion. At the mid-range, GE aviation valuation is estimated at $65 billion. With General Electric trading at a market capitalization of $112 billion, GE stock does seem attractively valued.

My Final Thoughts on GE Stock

Besides GE Aviation providing growth support in 2020, I also remain positive on GE Healthcare. For FY2019, the segment reported revenue of $19.90 billion, order intake of $21.20 billion and profit margin of 19.5%. Even with muted top-line growth, the segment adds to cash flows with an improving profit margin.

It is the power and renewable energy segment that still remains a drag on profitability and cash flows. General Electric is already considering sale of steam power, and in 2020 there should be further clarity on the roadmap for these segments.

Overall, with deleveraging and with cash flows from aviation and healthcare segment, GE stock does look attractive. Some correction can’t be ruled out after a sharp rally in the last few months. However, any correction will be an opportunity to accumulate GE stock as Larry Culp continues to make the right moves.

Faisal Humayun is senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.

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