GE (NYSE:GE) the iconic, "financial in industrial drag" for the two decades from 1980 through 1999, is now what Jim Cramer would call a "battleground" stock: the bulls and bears are fighting over where they think the stock will end up, whether or not the dividend will be maintained, and what GE's fair/intrinsic value is today.
The Deutsche Bank analyst has done a good jib identifying the "cash-flow" issue, raising a red flag about declining "cash-flow-from-operations" (i.e. CFFO) as far back as last January '16.
While the technicals of GE will be covered towards the end of the article, GE cratered after the July '16 earnings report, falling from $33 on July 20th of last year to $28.19 as of early November '16, and the stock has struggled ever since.
Let's go the numbers:
|Q1 '17||Q4 '16||Q3 '16||Q2 '16|
|2019 est EPS||$2.12||$2.12||$2.24||$2.28|
|2018 est EPS||$1.89||$1.90||$1.93||$1.98|
|2017 est EPS||$1.64||$1.63||$1.66||$1.72|
|2019 est EPS gro rt||12%||12%||16%||15%|
|2018 est EPS gro rt||15%||17%||16%||15%|
|2017 est EPS gro rt||10%||9%||11%||14%|
|2019 est revenue||$137.4||$136.9||$148.9||$139.9|
|2018 est revenue||$132.1||$133.4||$134.4||$130.5|
|2017 est revenue||$126.0||$125.2||$126.2||$125.5|
|2019 est rev gro rt||4%||3%||11%||7%|
|2018 est rev gro rt||5%||7%||7%||4%|
|2017 est rev gro rt||2%||1%||1%||0%|
- Source: Thomson Reuters I/B/E/S estimates for q1 '17 as of June 5th, 2017
- "est" = estimated
- "gro rt" = growth rate
A couple of items to note:
Dollar estimates for EPS and revenue has started to stabilize in 2017, after Q1 '17 results. On the Q1 '17 earnings call, GE management affirmed earlier 2017 guidance of 3% - 5% organic growth and 100 bp's of operating margin expansion.
What I don't like to see is that estimated EPS growth is coming down from solid mid-teens rates as of late '16 to low teens rates as of Q1 '17, which tells me that the margin gains are not coming as fast as GE and maybe Trian had hoped.
In Q1 '17 GE repurchased $1.5 of stock but here is what I thought was interesting: GE retired $5 bl of long-term debt too, reducing long-term borrowing from $105 to $100 bl as of 3/31/17.
Ge management reiterated its $12 - $14 bl cash-from-ops cash-flow target for full-year 2017 too. Here is how those numbers could fall out:
|Stmt of cash-flow||estimates|
|CFOA||$12 - $14 bl|
|-capex||$4 - $6 bl ?|
|Free-cash-flow||$7 to $9 bl|
|- dividend||$8 bl (ann'lzed based on q1 '17)|
|- repo's||$6 bl (ann'lzed based on q1 '17)|
|Surplus / (deficit)||($5 - $7 bl deficit)|
Source: cash-flow history on spreadsheet, mgmt guidance on '17 cash-flow
Readers should please take the above model as a very rough and crude cash-flow projection based on some historical numbers and mgmt statement, etc.
GE Industrial capex looks to be roughly $1 bl per quarter, but that doesn't include sales or dispositions of units, etc. Those sales will be a contributor to cash-flow over the near-term.
The interplay of the dividend and share repo are such that as GE buys back stock, there is also less dividend dollars to pay out as fully diluted shares outstanding decrease.
Since mid-2015 GE has reduced their shares outstanding by roughly 7% and since the peak shares outstanding in 2011, GE has reduced their fully-diluted share count by roughly 18% - 20%.
In addition, which gets back to the original headline on GE and the credit rating, to fill the return-of-capital gap on GE, does not look like it would require a big term-debt issuance for the industrial giant.
Hence, the point being that the A1/AA- credit rating leads me to conclude that GE still has financial flexibility to fund a dividend should they need it for 12 - 18 months.
Here is a longer-term "weekly chart" of GE that shows the stock testing its 200-week moving average, which is a technical point I pay attention to for establishing new positions or adding to existing positions (or selling positions for that matter).
You can see the stock is now trading below the trendline off the March '09 generational low for the SP 500, but is still sitting above the 200-week moving average.
Investors have gotten their best pullback in the stock since the 2016 announcement that GE Capital was being divested.
Getting a 2nd opinion from an experienced technician, the $27 area is expected to be solid support for GE. A higher volume trade through that price area wouldn't be good. The next stop would likely be the $25 area for GE or about the price where GE Capital's divestiture was announced.
Valuation / Fundamentals:
The mid-single digit organic growth and margin expansion is resulting in still low-teens EPS growth expectations for GE.
The 3.5% dividend yield with the stock trading at $28 is another plus.
The sentiment has changed on GE in the last year after the 2015 euphoria around the sale of GE Capital, and that is another aspect that is intriguing. Price estimates have come down and analysts have turned sour on the stock as the turnaround has taken longer-than-expected.
Morningstar still holds a $32 intrinsic value estimate GE and majority of the Street "price targets" reside in the low to mid $30's.
Deutsche Bank has a $24 estimate on the stock.
EPS and revenue estimates must stop declining and with GE lapping Q2 '16 and the drop from $33 in July '17, I'd like to see the EPS and revenue estimates for 2018 start to increase.
Torturing the statistics, if we assume GE can earning $2.25 - $2.50 in the out years, 2018, '19 and beyond, and we put a 15(x) multiple on GE, $35 would be likely fair value estimate that I come up with, assuming that the numbers stop declining.
Summary / Conclusion:
GE insiders and executives were buying the stock in April and May '17 as Briefing.com noted that three GE insiders bought reasonable chunks of shares:
- 4/25/17: Briefing reported a 20k share purchase worth roughly $600,000
- 5/12/17: Jeff Immelt bought 100k shares worth $2.8 million
- 5/16/16: GE Director purchases 16k shares worth $440,000.
- 13F filings showed that Trian raised their stake in GE as well, per Briefing.com
Jeff Immelt's buy was reported right when the stock was trading where it is today, $28.03.
The Deutsche Bank analyst did a good job with their research, but as a former credit analyst, I hang my hat on what the rating agencies think about a company's liquidity and financial flexibility.
The fact that GE is still rated low AA, High A by Standard & Poor's and Moody's is a good sign for GE's creditors and the dividend.
The last few years, Caterpillar was probably in worse shape than GE in terms of questions over the dividend and that was a few years, and CAT is still rated A2. (No positions).
To be upfront with readers, GE is a 3% position in client accounts, and the largest industrial position owned by clients (although we've hedged it with the Vanguard and SPDR Industrial ETF to a small degree) and the stock has dramatically underperformed in the last 12 months:
|7/1/16 to June 2nd '17|
That is painful for sure.
The July '17 earnings report will be critical as will guidance for the 2h '17 and the cash-flow guidance relative to the rest of the year.
Finally, from a portfolio construction perspective, holding on to GE with an overweight in Technology and some of the FANG stocks, means that clients have an uncorrelated asset (so to speak) and that portfolio's aren't loaded up with stocks that are momentum or "trending" in character.
GE was added in small quantities again today.
A trade below $27 on heavy volume is likely a red flag.
On the Q1 '17 conference call, the CFO said that GE will see a significant improvement in CFOA in Q2 '17. Morningstar noted that there were timing issues in Q1 '17 that caused the cash-flow misfire.
Investors need to see this for sure.
Disclosure: I am/we are long GE, VIS, XLI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.