In the fourth quarter of 2019, optimistic analysts opined that General Electric’s (NYSE:GE) aviation business is worth $100 billion. GE stock currently trades at a market capitalization of close to $57 billion. General Electric might therefore seem to be an attractive investment.
However, I believe that an uncertain business environment would imply further downside for the stock. Possibly, GE stock would be interesting below $5 in the coming months.
Talking about uncertainty, the head of the World Health Organization opines that the “the worst is yet ahead of us.” Therefore, it might be too early to discuss a time line for economic recovery.
A similar view comes from a Harvard Business Review article related to the novel coronavirus. The author believes that “another wave of infections remains a real possibility, meaning that even countries that acted relatively quickly are still at risk every time they nudge their economies back to work.”
The outlook remains grim even from a consumer sentiment perspective. In a recent poll, “the majority of people in 10 out of the 15 countries surveyed say a quick economic recovery is unlikely once the lockdown from the pandemic is lifted.”
I am not painting a doomsday scenario. The point is that there is likely to be several quarters of weak numbers from General Electric. That’s a factor that will be further discounted in GE stock in the coming months.
Rating Downgrades Can Trigger Losses for GE Stock
Recently, S&P Global Ratings revised General Electric’s credit rating outlook to “negative” from “stable.” General Electric still commands a rating of BBB+, but I believe that a rating downgrade is likely in fiscal year 2020.
It’s important to note that the company’s aviation business is a key cash flow driver. According to Cowen’s, “airlines will be 30% smaller at the end of this year than they were at the start of the year.”
Cowen’s also believes that it will take three to five years for airline industry demand to return to fiscal 2019 levels. While this forecast is for the United States, I believe that global trend is likely to remain weak. This will impact the GE Aviation business.
Last month, GE Aviation announced the division will cut 10% of its U.S. workforce. Earlier this month, the aviation division further announced that it will furlough 50% of its engine manufacturing staff. This is a clear indication of the extent of downturn in the aviation segment. GE stock will trend lower in the coming quarters as free cash flow is impacted.
The company withdrawing guidance for the year is yet another indication of the level of uncertainty. Since I expect the stock to trend lower, it’s worth talking about the valuations. General Electric had initially expected earnings per share of 55 cents. Considering the demand destruction globally, an EPS of around 20 cents is a good base-case scenario.
With GE stock trading at $6.50, the price-earnings ratio for the year comes to 13. Therefore, valuations are certainly not inexpensive with a possibly of 12-18 months of challenging economic conditions.
The Pandemic Will Impact Deleveraging Plans
Among its key financial goals for the current year, General Electric intended to reduce leverage. GE was targeting leverage of 2.5 for the current year.
However, given the economic uncertainties, it’s unlikely that the target will be achieved. S&P Global Rating’s view is that General Electric will be unable to reduce leverage below 3.5 in FY2021. This is one of the reasons S&P is considering a potential downgrade.
One of the sources of cash for deleveraging was the sale of its stake in Baker Hughes (NYSE:BKR).
I must point out here that the company has ample liquidity to navigate the crisis. As of March 2020, the company had cash and equivalents along with restricted cash of $47 billion. The company has also refinanced a credit facility maturating in fiscal 2021 with a new $15 billion credit facility.
My Final Views on GE Stock
I have talked about the medium-term concerns for General Electric. These factors are likely to take GE stock lower.
However, I believe that CEO Larry Culp can transform the company over the next few years. The “black swan” event does delay the company’s plans, but General Electric is well positioned financially to survive and grow beyond the current crisis.
Therefore, GE stock will certainly be attractive around $5.
Faisal Humayun is a 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.
