Give credit where credit is due. General Electric (NYSE:GE) has performed better of late. GE stock has responded in kind.
Indeed, November reportedly was the best month in the stock’s history, as GE rallied 40%. The strength has continued in December, with the stock reaching its highest level in almost nine months.
There’s a logic to the rally. GE seems to be making long-awaited progress in its turnaround. The external environment is improving as well. With GE stock hitting multi-decade lows May, and threatening those levels again in September, the stock might even have been ‘due’ for a rally, if not quite one to this extent.
But at this point, it’s time to get cautious again. I’m happy for long-suffering GE shareholders. As I’ve written before, I’m still rooting for what remains a great American company (and a still-significant employer). Yet the challenges here are real. They long predate the novel coronavirus pandemic and they will last after normalcy returns.
Put simply, General Electric still has an awful lot of work left to do. With GE stock near $11, that fact no longer seems quite priced in.
The Turnaround Gains Steam
Again, GE deserves credit. The external operating environment in 2020 has been disastrous, yet the company has managed to hold up reasonably well.
GE even managed to generate a surprise profit in the third quarter, albeit on an adjusted basis. Free cash flow from the industrial business (i.e., excluding GE Capital) was over $500 million. And the company guided for positive FCF in 2021.
Both figures are impressive — and needed. GE Aviation, in particular, has been hammered by the pandemic and the ensuing shutdown in travel. GE Power, which benefits from large-scale projects, has taken a hit as sales have slipped into 2021 and beyond. Even the healthcare business has been hurt, as non-essential surgeries have been postponed.
Revenue in Q3 was down 17% on a GAAP (Generally Accepted Accounting Principles) basis, and 12% for the industrial business excluding the impact of sold businesses. Those declines came from market pressure, not poor execution or competitive factors. GE did the best it could do — and, in context, did well.
That’s not something that has been the case for General Electric in years past, when execution was inconsistent at best. That aside, free cash flow has been a long-running concern, as it often hasn’t met with reported adjusted earnings metrics. Strong news on both fronts seems to strengthen the GE story.
At the same time, the balance sheet is improving. GE this week highlighted another $4 billion in balance sheet improvements, including pre-paid pension expense. For the year, GE expects to reduce debt by some $14.5 billion.
Is Good News Priced Into GE Stock?
Reviewing the operating and balance sheet improvements, GE stock seems like a buy. The news is getting better.
But if you look closer, the concerns haven’t gone anywhere yet. Adjusted earnings per share were positive in Q3 FY2020, and better than expected. They still declined 60% year-over-year, despite hugely aggressive cost-cutting.
As for the balance sheet efforts, the debt reduction isn’t coming from operating cash flow. Rather, GE sold its Biopharma business for $20 billion in a deal that closed at the end of March. It also sold its lighting business and began the process of exiting the oil and gas business (which raised another $3 billion).
And so there remains the very real question of what, exactly, has changed for GE stock. This still is a company that is trying to shrink its way to growth. Its workforce has declined dramatically, thanks to asset sales and layoffs at the businesses that remain.
Those businesses retain significant challenges. Healthcare is attractive, yes. Power remains a mess, Aviation is challenged, and Renewable Energy is relatively small and still unprofitable.
Those problems existed before the pandemic. They’re not new. And they’re not close to fixed.
In fact, it’s going to be hard to fix those problems. GE still has a significant pension deficit, a “black box” in GE Capital, and relatively minimal earnings and free cash flow expectations even for next year. At this point, the easy fixes have been made. There are no more businesses to sell without crushing earnings power, and market growth in Power and Aviation may well be negative for years to come.
The story behind GE stock is better. But I’m not sure that means it’s good. And with the stock now trading at more than 20x 2022 earnings estimates, it needs to be.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.
