In "General Electric: Low Rates Trump Growth... For Now," an analyst from JPMorgan (NYSE:JPM), Mr. C. Stephen Tusa, described General Electric (NYSE:GE) shares as a stock that should be avoided and he provided the following thoughts on the company:
On General Electric, we expect core operating performance to track below plan driven by weak fundamentals, particularly in oil & gas and transportation markets with little offsets from other segments. Additionally, FCF remains weakest in the sector, and, balance sheet optionality is below average. With this backdrop, we see valuation as expensive (~5-10% weighted premium), with limited incremental catalysts to change the narrative.
This article is the latest of a string of bearish calls on GE made by Mr. Tusa (and team) and to sum up all of the recent reports - the team believes that GE shares have run too far too fast (i.e. overvalued) and there are no near-term catalysts to change the narrative. Mr. Tusa brings up some valid points in the bearish GE articles, but in my opinion, the common themes of shares being "overvalued" and there being "no near-term catalysts" should not be considered significant concerns for investors with a long-term perspective.
In addition, Mr. Tusa has a price target for GE of $26 per share, which is well below the consensus estimate of ~$33 per share, so this should be taken into consideration when reading these articles.
I agree with the latest article in that GE's operating results may be under pressure for the remainder of 2016, with the oil and gas segment playing a significant role, but I believe that it would not be wise for long-term investors to sell their GE shares due to the short-term concerns that have been highlighted in these articles.
The Oil & Gas Segment, The Struggle Is Real
The Oil & Gas ("O&G") segment has faced significant headwinds in the low commodity price environment that began when oil and gas prices fell off of a cliff in late-2014. The graph below shows just how far the WTI crude oil prices have fallen over the last two years.
(Source: Bloomberg --edited by author)
The current WTI price is well above the 2016 lows but many pundits are predicting that we are not likely to see $60/barrel until 2017, at the earliest, which will likely add further downward pressure to the O&G operating results in the quarters ahead.
A review of the most recent operating results shows that the struggle is real. For example, for Q2 2016, the segment reported YoY declines in revenue and profit.
(Source: Q2 2016 Earnings Presentation)
Mr. Tusa is correct in that the operating results for this segment are not likely to improve in the near term, but as I described in "GE: I Too Still Believe In The Oil (And Gas) Business," a recovery in this industry will eventually turn a headwind into a tailwind for the company.
In my opinion, if your investment time horizon is longer than 1 to 2 years, then a downturn in one of the industries that this large conglomerate operates in should not be considered a major concern with a perfect example being GE investing in Aviation during the early 2000s when the industry was in a downturn (this example was described in the article linked above).
In a recent investor presentation, management discussed the O&G segment's prospects for 2016 and projected for full year revenue and profit to be down by double digits.
(Source: Morgan Stanley Laguna Conference)
However, management still believes that the O&G team is controlling what can be controlled and are appropriately cutting out costs in order to put the segment in the position to prosper when the industry begins to improve.
The Other Segments, Will It Be Enough?
O&G is an important operating segment for GE, as the segment is currently the fourth largest operating division, so the anticipated 30% decline in profit will indeed hit the consolidated results.
To assess the following statement, "...we expect core operating performance to track below plan driven by weak fundamental, particularly in oil & gas and transportation markets with little offsets from other segments," I created the table below with the use of the most recent 10-Q.
|Revenues||2016||2015||$ Chg||% Chg|
|Oil & Gas||$6,533||$8,157||($1,624)||-20%|
|Appliances & Lighting||$3,663||$4,177||($514)||-12%|
|Oil & Gas||$628||$1,102||($474)||-43%|
|Appliances & Lighting||$211||$268||($57)||-21%|
|Operating Profit Margin||YoY Chg|
|Oil & Gas||10%||14%||-4%|
|Appliances & Lighting||6%||6%||-1%|
|Total Profit Margin||13.6%||15.4%||-1.8%|
(Data from June 30, 2016 10-Q - $ is in millions and figures are for the six months ended June 30, 2016 and 2015; table created by W.G. Investment Research.)
Observations from the table:
- The YoY increase in consolidated revenue is largely a result of the Alstom acquisition.
- The Aviation, Healthcare, and Renewable Energy segments are the standout performers with YoY increases in both revenue and profit.
- The consolidated profit margin for the six months ended June 30, 2016 is only slightly below the 2015 figure, even with the significant decline in the O&G segment's profit.
A review of GE's operating results over the first six months of 2016 and 2015 supports Mr. Tusa's assessment that the other segments' may not be able to offset the declining O&G results, but again, this is a short-term concern. Moreover, management recently reaffirmed the 2016 EPS guidance of $1.45 to $1.55 during the Q2 2016 conference call, so investors should not yet be concerned with results tracking below plan for 2016.
To combat margin compression over the longer term, management estimates further cost synergies from the Alstom acquisition and the company recently acquired two additive manufacturing companies that are expected to reduce product costs by $3-5b over 10 years.
GE shares will not make you rich over the next 6 months, but in my opinion, the long-term story for this conglomerate is still intact. Mr. Tusa raises valid short-term concerns but I believe that this conglomerate has several catalysts in place that will help GE shares outperform the market through 2018.
GE is a long-term buy at today's price, and any type of improvement in the oil and gas industry will bode well for this company and its shareholders. Long-term investors should enjoy being paid an above-average dividend (~3% yield) and wait for the pieces to fall into place.
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Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
Disclosure: I am/we are long GE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.