General Electric (NYSE:GE) could be a good turnaround story, especially now that it is producing free cash flow (FCF). That is my conclusion after studying the company’s latest second-quarter earnings release from July 27. As a result, GE stock could be worth 43% more at $150.53 per share.
That would move the stock to where it was almost four years ago in late 2017.
In effect, it would signal that GE was moving up the other side of its turnaround.
GE reported orders up 33%, GAAP revenue up 9%, and an industrial profit margin of 5.3%. As a result, its adjusted earnings per share (EPS) was 19 cents per share. But more important than anything, it reported a huge turnaround in its industrial free cash flow.
General Electric’s Gushing Free Cash Flow
I believe that investors will be impressed with the company’s gushing cash flow. This can be seen in the table on page 11 of its earnings release. That shows that the company had $388 million in industrial free cash flow during Q2. This was a complete turnaround from the $1.595 billion it lost last year.
Keep in mind that GE makes many adjustments to normal GAAP-based accounting to come up with this figure. For example, its footnote says this:
“We believe investors may find it useful to compare GE’s Industrial free cash flows* performance without the effects of cash used for taxes related to business sales and the factoring program discontinuation. We believe this measure will better allow management and investors to evaluate the capacity of our industrial operations to generate free cash flows.“
In other words, the actual cash flow performance was different from these industrial free cash flow numbers. But GE can justify this by assuming that certain one-time effects will stop in the future and this allows the investor to see through these adjustments to the underlying cash flow gains.
I am generally ok with these kinds of adjustments as long as they don’t happen every year and are usually large numbers.
But here is the most important thing. General Electric is now projecting that its full-year 2021 FCF will reach between $3.5 billion and $5 billion. That is higher than its previous estimate of between $2.5 billion and $3.5 billion. It also implies that the full-year FCF margin will be about 5.5% to 6% (based on analyst revenue projections for 2021 of $77 billion or higher.
Valuing General Electric Stock
Let’s assume that by the end of 2022, the company can make at least a 6% industrial FCF margin. Since analysts covered by Seeking Alpha project that revenue will hit $81.93 billion (call it $82 billion), this implies FCF of $4.92 billion. That is seen by multiplying $82 billion by 6%. Let’s move that to $5 billion for simplicity’s sake.
Now, the market will likely give GE stock a market value using a 3% FCF yield. For example, if we divide $5 by 3% the resulting target market value is $166.67 billion.
This represents a potential 43.1% gain over its market cap of $116.45 billion at the close on Monday, according to Yahoo! Finance. I think they have the most accurate market cap calculations.
In other words, GE stock is probably worth $150.53 per share or 43.1% over Monday’s close of $105.19.
What to Do With GE Stock
Keep in mind that this price target assumes that the company will continue to benefit from a turnaround in all its operations. That could lead to an even higher FCF margin than my estimate of 6% against higher sales.
Some analysts don’t see it this way. For example, Refinitiv‘s survey of 13 analysts, published by Yahoo! Finance, has an average price target of $121.78 per share. Moreover, Seeking Alpha’s analyst survey of 20 analysts shows that the average target is $116.39 per share. Both of these are well below my projection of a price target of $150.53.
However, given the progress the company seems to be making producing FCF, I think it is not too far-fetched to expect a 43% gain in GE stock. Investors will want to start to take advantage of this cheap price, especially if my target price comes to pass.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
