- GE reported a better-than-expected quarterly report.
- Larry Culp is making the right moves to execute a successful turnaround process.
- It's not about past earnings. It's about GE's future earnings, and the company's EPS growth will likely be much higher than its competitors.
- GE's businesses are extremely undervalued relative to the company's market cap and enterprise value.
- GE has significant long-term upside potential, and the stock should be substantially higher 1-3 years from now.
General Electric (GE) has been under immense pressure over the past 2 years.
In fact, shares are still down by around 66% from their highs in late 2017. However, the company is finally starting to show signs of improvement, and the turnaround process, while likely a lengthy one, should prove to be constructive and fruitful for shareholders.
GE delivered better-than-expected earnings, and the company's businesses continue to appear drastically undervalued. While this turnaround process will likely prove to be a lengthy one, GE should be a lot higher in 1-3 years.
While the company's market cap is only $88 billion, and its enterprise value is at $144 billion, the company's businesses appear to be worth a lot more, about $100 billion more.
GE Beats Estimates
The company's shares popped by 4.5% on the day, after being up by as much as 11% in pre-market.
- GE crushed EPS estimates, delivering 14 cents vs. an expected 9 cents per share, beating by 55%.
- The company beat on revenues, delivering $27.3 billion vs. an expected $27 billion.
- Aviation produced a solid profit of $1.7 billion, 4% increase YoY.
- Despite enormous difficulties, GE Power produced an operating income of $81 million.
- GE Capital further reduced liabilities by another $1.1 billion in the quarter.
- GE's industrial free cash flow came in at a negative $1.2 billion for the quarter, better than many analysts had expected.
Why were shares up so much?
Larry Culp also reaffirms full-year guidance
GE's new CEO Larry Culp appropriately described 2019 as a "reset year". Prior to this (2017/2018), GE was in a period of steep decline. 2019 is a transition/stabilization year, and future years like 2020/2021 should enable GE to significantly restructure and improve operations.
Beyond that, GE could return to its industrial dominance in various sectors and could deliver much higher EPS that many market participants currently expect.
GE's Earnings: It's Not About the Past. It's All About the Future
GE is clearly experiencing an earnings decline right now. Due to poor management and other elements, GE's EPS fell by around 70% in recent years, to an expected EPS of just 56 cents this year.
However, this being the stabilization/transition year, EPS should rise considerably in future years. In fact, we already see consensus estimates for 71 cents in 2020 (27% YoY growth), and some analysts see 94 cents, and $1.07 in 2021, and in 2022.
So, What Could GE Earn Going Forward?
I know it is difficult to give GE credit for potentially beating EPS in the future, but I believe it is quite possible, especially with new CEO Culp at the helm, and with such low expectations for the company.
Estimates going out beyond 2020 are at extremely low levels due to rock-bottom expectations. I expect GE could surprise to the upside and deliver at least $1 vs. expected 94 cents in 2021, and $1.20 vs. an expected $1.07 in 2022.
If GE earns just 71 cents in 2020 (consensus estimates), a rise to $1 in EPS will provide GE with a 40% YoY EPS growth rate, followed by another 20% to $1.20 in 2022. This implies GE is trading at 14 times forward earnings, at about 10 times 2021 (my EPS estimates), and at around 8.3 times 2022 (my EPS estimates).
GE's Valuation Vs. Competitors
If we compare GE's valuation to a similar company, United Technologies (UTX) trades at about 16.25 forward estimates. However, UTX's 2021 estimates call for EPS of $9.66 and $10.70 in 2022. This puts UTX's 2021 expected P/E at 14.7 and 2020's at 13.3. This is much higher than the 10 and 8.3 valuation GE can offer due to its turnaround-induced elevated earnings growth rate.
UTX is just a single random example, but other industrial companies with similar operations trade under comparable dynamics. What makes GE so unique is its ability to produce higher-than-normal earnings growth over the next several years. This essential element makes GE such a compelling stock to hold over the next 3 years.
GE's Businesses Significantly Undervalued
I've done the sum of GE's part analyses in numerous other articles, and the conclusion I arrived at in my latest piece is that GE's businesses are worth approximately $275.5 billion.
Once we subtract the approximate $29 billion in unfunded liabilities, the estimated worth of GE's businesses is about $246.5 billion.
GE's current enterprise value is only $144 billion, providing a disconnect of about $102.5 between the worth of GE's businesses and the company's depressed EV.
Approximate Business Values
- GE Aviation: $122 billion
- GE Healthcare ($60 billion + $21.4 billion biopharma spinoff): $81.4 billion
- GE Power: $29 billion
- GE Oil and Gas: $17 billion
- GE Transportation: Transportation $11.1 billion
- GE Renewable Energy: $10 billion
- GE Capital: $4 billion
- GE Lighting: $1 billion
- GE Total value: $275.5 billion
We see that, at $275.5 billion, GE's businesses appear to be worth far more than the company's current $144 billion EV and dwarf the company's current $88 billion market cap.
GE's Strengthening Technical Image
GE's technical image also appears to be improving. The 3-year chart illustrates that, after about 2 years of very steep declines, the stock finally bottomed around $6.65 in late December. Now, the stock appears to be making a recovery, making a higher low, and is likely on its way to making a higher high as well.
Nevertheless, we're not likely to see rapid appreciation in share price at this time, as there are still various fundamental elements plaguing the company. However, the problems appear to be mostly transitory and fixable. Ultimately, GE's stock should move higher after a period of somewhat volatile sideways price action.
Take on Tusa
JPMorgan's Stephen Tusa, a well-known GE bear who recently lowered his GE price target to just $5 found "optimism in Q1 results". Tusa has done some excellent work on GE and has made some great calls on the stock price in the past.
However, the tide has turned, and it is likely that as GE continues to improve, Tusa may find more optimism to deal with. This will likely result in higher price targets by Tusa and other analysts, putting GE's stock price on a sustainable upward trajectory at the same time.
Moreover, while Tusa may be the most bearish analyst on the street, many are not nearly as pessimistic. For example, Jim Corridore of CFRA Research rates GE a buy and has a $12 12-month price target on the stock.
In fact, the current consensus 12-month price target on GE is $12.50, with higher end estimates ranging up to $16.
The Bottom Line
Undoubtedly, GE's turnaround process will not be a quick and easy one. Yet, with new management, and a strategy designed to make GE a much leaner and more efficient enterprise, the company has significant upside potential over the next 1-3 years.
GE is already showing signs of delivering better than expected results, and the company's EV value is only $144 billion right now, arguably undervalued by roughly $102.5 billion. This implies the EV would likely need to rise by around 70% to better reflect the businesses combined value.
Since the increased value of GE's businesses would enable the company's market cap to rise by about $102 billion (per my estimates), this implies the $88 billion market cap could grow to around $190 billion, implying a possible stock gain of roughly 116% from current levels. A 116% gain from current levels would elevate GE's stock to $21.60.