General Electric‘s (NYSE:GE) “lackluster” earnings for Q2, as Barron’s magazine called them, makes investors wonder what is next for the conglomerate. The truth is a lot of bad news is already discounted in the GE stock price, including the lousy Q2 earnings. In that sense, maybe there is some light at the end of the tunnel.
And there is no mistaking how bad those earnings were. All measures of profitability and cash flow were negative in terms of growth.
The best that GE Chairman and CEO H. Lawrence Culp Jr. was to say this: “… we continue to plan for a prolonged return to prior levels of activity.”
He was referring to the company’s aviation division, but it could easily apply to the rest of the company’s divisions. Besides aviation, it has three other main areas: power, renewable energy, and health care.
This does not include its money-losing GE Capital division. That division has continuously been losing money from its foray into long-term care insurance.
Industrial FCF Could Lead the Way
Aviation used to be the largest in terms of revenue, but it is now second, after health care. That is because of the 56% decline in revenue, the worst of all four areas, in aviation over the past six months compared to last year.
But I digress. The point is, all this terrible negative growth may actually now have hit a trough. In fact, Culp said this in the earnings release: “We expect to return to positive Industrial free cash flow in 2021.” Keep in mind that in the last six months to June 30, the company lost $4.275 billion in negative industrial FCF.
If that happens, you will be sure that GE stock will likely be much higher by then. By the way, there is not much difference between regular FCF and what GE calls industrial free cash flow. The latter includes some taxes. It tends to make the cash flow worse.
The bottom line is that while this is number is negative, the company will be adding to its debt pile or reducing cash in order to finance the negative FCF. So by definition, as soon as industrial FCF turns positive, it won’t be depleting its cash resources.
This is important because GE has a ton of debt. It’s more than $34 billion, even after deducting $25 billion in cash, according to page 15 of the latest earnings report. Keep in mind that GE’s market capitalization is $58 billion, but total shareholders’ equity is only $33.7 billion.
Luckily, through asset sales, the company has reduced its debt by over $9.1 billion so far this year.
What to Do With GE Stock
Barron’s reports that a number of large funds have been selling GE stock. In fact, Nelson Peltz’s Trian Fund Management started selling shares which it acquired in 2015. It now holds less than half its original stake, all at loss. Barron’s points out that at the time it started buying the GE stock, it was Trian’s largest position. Ouch.
And why shouldn’t they? The stock is down more than 40% so far this year and over 26% in the past year. In the past five years, GE stock has lost more than 75% of its value. That is a horrific performance for such a large market cap company.
The problem is that its aviation division and long-term care insurance portions of GE Capital have overtaken the positive growth that other divisions normally provided. Now even those growth areas are in decline. However, that may be temporary. As I pointed out, the CEO now believes that the stock will have positive free cash flow by 2021.
If that occurs, I believe you will see the stock doubling in value. Here is why. Let’s say that the company can produce up to $4 billion in positive industrial free cash flow by the end of 2021. With a 3% to 4% FCF yield, the stock market capitalization would be between $100 billion to $133 billion. That represents a gain of 72% to 129% over today’s price for GE stock.
So, as CEO Culp said, there may be a prolonged return to prior activity levels, but most of the bad news seems to be incorporated into the GE stock. Patient investors will look to make an investment at various downturns in the stock.