The recent market correction has impacted stocks across the sectors. General Electric (NYSE:GE) touched a 52-week high of $13.26 in February 2020. As I write, the stock has plunged to a 52-week low below $6. Even after a sharp decline, I remain bearish on GE stock for the foreseeable future. However, it is worth keeping on your investment radar. This column will discuss the near-term concerns and the reasons to be positive on General Electric for the long-term.
It is worth mentioning at the onset that in an emergency monetary action, the Federal Reserve cut its target interest rate to near-zero levels. The Fed also announced purchase of $700 billion in Treasury bonds and mortgage-backed securities. This failed to calm the markets, with the Dow Jones Industrial Average plunging by 10% in trade after the announcement.
The reason for stating this fact is to underscore the point that the markets are discounting a potential recession. According to J.P. Morgan, U.S. GDP is expected to shrink by 2% in the first quarter of 2020 and by another 3% in Q2 2020. In addition, Euro-zone GDP is likely to contract by 1.8% in Q1 2020 and 3.3% in Q2 2020.
The relevance of these numbers in discussing GE stock is as follows — General Electric provided an investor outlook for fiscal year 2020 with earnings per share guidance of 55 cents (mid-range). However, the company has factored the impact of COVID-19 only for Q1 2020.
With recession likely in Q2 2020, I expect General Electric to revise the guidance for the year. This uncertainty is the reason you may want to stay in the sidelines.
Positive Outlook Makes GE Stock Attractive
Recession is likely in the first half of the year. However, the markets seem to be in panic mode. This is likely to reverse at some point, and stocks will trend higher from their current, deeply oversold levels.
Besides the potential downward revision in guidance for FY2020, I believe that there are several positive triggers for General Electric.
For instance, General Electric is on a deleveraging path. From a net-debt-to-EBITDA of 4.8 in FY2018 the company expects leverage to decline to 2.5 for the current year. With improvement in credit metrics, the company is likely to be re-rated. Further, as interest cost declines, the bottom line will improve.
For the current year, General Electric expects industrials free cash flow in the range of $2 billion to $4 billion. In addition to that, the company expects positive FCF from the power and renewable energy segment by FY2022. These segments have been a drag on FCF and if this trend reverses, GE is positioned for significant value creation.
The company’s aviation business is a cash cow, and with a record order backlog of $273 billion, the segment has clear cash flow visibility. Besides a commercial portfolio, the segment has been expanding its military business. This is likely to ensure that order backlog growth remains robust. It’s important to note that even with the headwind related to 737 MAX, the company is expecting FCF similar to FY2019 levels.
Besides the industrials segment, the company’s healthcare business has also been generating positive FCF. With GE expecting margin expansion and FCF growth in FY2021 and beyond from the healthcare business, the company’s FCF visibility is likely to be in the range of $6 billion to $8 billion by the next 24 months. This is likely to translate into GE stock upside.
My Concluding Views
Considering the EPS guidance for FY2020, GE stock is currently trading at a price-to-earnings-ratio of 12.4. This might look attractive, but the stock is discounting a potential revision in guidance as the impact of COVID-19 is likely to sustain beyond Q1 2020.
Therefore, it makes sense to wait. I believe that the stock will be available at lower levels in the coming months.
From an 18-to-24 month-perspective, there are ample positive triggers that make GE stock worth considering. However, there is too much panic in the markets now for investors to make decisions based on a medium to long-term horizon.
Faisal Humayun is senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with a focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
