As earnings season nears for General Electric (GE), it’s important for the company’s shareholders, as well as market watchers, to take stock of where things are now and what should be anticipated for the firm’s press release. After all, this will be the first full quarter with new management in charge of the business, and with business having spent the past few years in the gutter, there’s a lot of pessimism regarding the company. Fortunately, while there are true concerns regarding General Electric and its prospects, there also are positive aspects that shareholders can keep an eye out for that might create significant value for the firm in the years to come.
Anybody who knows my work on General Electric understands that I believe the firm’s Aviation segment is its crown jewel. Years of strong sales growth, fat margins, and continued impressive performance at a time when most of the industrial conglomerate has suffered points to a real winner. So far this year, I don’t expect anything to change on that front and, absent a global economic downturn (which could be a reality in the next year or two depending on the Trump Administration’s trade wars and the normal economic cycle), we are likely to continue to see growth from the segment for years to come.
In the graph above, for instance, you can see sales and profits generated by Aviation for the five years ending in 2017. You also can see the profit margin associated with the segment as well. This is great, but it’s also important to consider that there are cyclical trends that should be taken into account. For instance, if you look at the graph below, you will see the difference in sales and profits generated by the segment between the third quarter and the fourth quarter of every year.
What this illustrates is that, over the five years covered, Aviation has a history of faring better in the fourth quarter of each year than it does in the third quarter. Why, precisely, this is a reasonable question, but what matters most is that this bodes well for shareholders who remember Aviation’s performance in the third quarter of 2018. Sales during that timeframe came out to $7.480 billion, while segment profits totaled $1.665 billion. To put this in perspective, the third quarter of 2017 saw revenue of $6.696 billion, while profits were $1.335 billion. This year-over-year growth, not to mention the historical trend of stronger fourth quarter results than third quarter results, implies that investors would be wise to anticipate a nice fourth quarter to end out 2018 and to get us started fresh now that 2019 is well underway.
Earlier this month, rumors began circulating that Apollo Global Management (APO) has either bid on or might be bidding on General Electric’s Capital Aviation Services (or GECAS for short). The rumored price tag discussed in the market was around $40 billion, but until some sort of news breaks on the matter, all we can do is speculate on the final outcome. If a deal to sell GECAS could be reached, the impact for shareholders could be significant since a $40 billion windfall in an asset-heavy space would allow for significant debt reduction and a further streamlining of operations.
As a watcher of General Electric, I hope this kind of deal comes to pass, but if the listed price is anywhere near what rumors suggested, it will have meant I was horribly wrong. In a prior article, where I stated that a sum-of-the-parts analysis implied a valuation for all of General Electric of between $223.75 billion and $354.09 billion (compared to the paltry $77.41 billion shares place the market cap at today), I stated that a fair price range for GECAS, based on my assessment of market competitor Aircastle (AYR), would be between $10.47 billion and $18.88 billion.
That disparity is glaringly large, but with assets (without factoring in any unstated liabilities for the segment) of $40.75 billion, it’s not too tough to see where the market might be coming from. This mistake on my part was due to assigning value to sales and profits as opposed to assets may end up being a great mistake since the end result would mean even more wiggle room for the conglomerate.
For the company’s fourth quarter earnings release, I have no idea if a deal will be announced or not, but I do believe there’s a reasonable chance that management will at least discuss the rumors and give some sort of hint as to what, if any, sort of transaction could take place.
Last year, the management team at General Electric announced plans to split up its Power segment into two separate operations with the company. My own opinion regarding this is that it could be setting the firm up to divest of some of Power’s assets. That said, even if we don’t see any developments on the Power front, there are plenty of assets that General Electric has that it could be focusing on unloading. Already, we have seen the firm announce plans to sell off some of its ownership in Baker Hughes, a GE Company (BHGE), but another firm that it could easily sell off would be its ownership in Wabtech (WAB) in the future.
Management does intend to divest of its Healthcare segment to some degree, so while we may have some developments on the planned IPO there, I don’t anticipate any further changes that are material in nature. That said, we could see developments regarding the firm’s other sets of operations, like what remains of its Lighting segment or something regarding some other non-core assets. Either way, with CEO Larry Culp likely wanting to reposition the company quickly and efficiently, it’s almost certain something substantive will be at least discussed along these lines during the quarter’s release and/or conference call.
Right now, I know there’s not a lot of confidence in General Electric, nor is there much in the firm’s management team (both, mostly, for good reason). Even so, there's upside potential here, especially if management can succeed in repositioning the firm and successfully engaging in at least one big asset sale that can be used for debt reduction. Because of this and because of my expectations centered around Aviation, I'm optimistic heading into the firm’s fourth quarter release, and I believe other investors probably should be as well.
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