General Electric: The Good, The Bad And The Ugly

Summary

• Will Warren Buffet save the day, again?
• I will highlight three things that investors should be closely monitoring in 2018 - The Good, The Bad, The Ugly.
• I plan to stay long General Electric.

General Electric (NYSE:GE) is a beaten-up industrial conglomerate that cannot seem to find its footing (and this is putting it lightly), but GE shares jump by over 4% on rumors that Warren Buffett may be interested in initiating a stake in the company.

Source: Nasdaq

It is hard to cheer for a 4% bump when the company's stock is trailing the performance of the S&P 500 by a wide margin over the last year but anything counts at this point in time.

In my opinion, a Buffett investment would go a long way when it comes to investor sentiment. A Buffett buy would be would just what the doctor ordered, but let's not get ahead of ourselves - i.e., investors should not go out and buy GE shares tomorrow on this news, of course, in my opinion. Also, let's remember that Mr. Buffett recently told CNBC's Becky Quick that he would buy GE at the "right number" so it is not like the rumors are coming out of left field.

I am [unfortunately] a long-time GE bull so I am obviously encouraged about the Buffett news (when there is smoke, there is usually fire) but, in my opinion, there are other reasons to like the stock around the $13 per share range. To consider GE's current state, I will focus on what I am calling; The Good, The Bad and The Ugly.

The Good - Improving Business Environment

The company's troubles have been well-documented here on Seeking Alpha, and I will get to some of them later in this article, but it is important to note that GE is operating in an environment that has promising business prospects. To put this into context, FactSet recently released several reports that supports the thesis that the global economy, obviously including the U.S., should have a strong start to 2018.

The Organization for Economic Cooperation and Development ("OECD") recently revised its economic outlook forecast, and now estimates that global real GDP growth will reach 3.9% in both 2018 and 2019 (an increase from the 3.7% experienced in 2017). Moreover, the OECD is now forecasting that U.S. economic growth will reach 2.9% and 2.8% in 2018 and 2019, respectively (an increase from the 2.3% experienced in 2017).

Source: FactSet, "Last Year's Economic Momentum Projected to Continue into 2018", March 21, 2018

In a separate report, FactSet highlighted the fact that the S&P 500 companies with more global exposure are expected to benefit from a weaker U.S. dollar and higher global growth. To this point, FactSet estimates that the S&P 500 companies that generate more than 50% of sales outside of the U.S. (i.e., more global exposure) are expected to report higher earnings and revenue growth in Q1 2018.

Source: FactSet, "S&P 500 Companies with More Global Exposure Projected to Report Higher Sales Growth in Q1", March 16, 2018

Before going any further, some may be asking why global growth forecasts matters for GE. For one, GE has an extremely global business and operates in industries that impact economies around the globe. And, GE's customer base is filled with many global companies. Based on data from GE's Annual Report, the company now gets well-over 50% of its revenue from outside of the U.S.

Source: 2017 Annual Report

Additionally, around 50% of GE's assets are outside of the U.S.

These data points do not make GE's "troubles" all of the sudden go away but, when taking a step back, I believe that this is exactly the type of environment that Mr. John Flannery, CEO, needs to change the narrative for this broken stock (and company). The global growth, if achieved, should be a significant catalyst for GE's earnings potential over the next 12-18 months. The Power issues (more on this below) will be too much to overcome over the next few quarters, but I anticipate GE's other businesses benefiting from the projected global growth highlighted above.

The Bad - Power

GE's Power segment was a bright spot for this company for many years, but things quickly changed in 2017. The operating segment's revenue was flat YoY but the earnings fell off of a cliff.

There were several factors that came into play for Power during fiscal 2017 (market slow down, excess capacity and inventory write-offs, structural costs, etc.), but the overall takeaway from the earnings release and management commentary during the conference call was that the turnaround for this unit will take some time, at least 12-18 months, in my opinion.

Source: GE's Q4 2017 Earnings Release

The struggle is real for GE's Power unit but, looking forward, the company may be able to use this period of time to reset expectations and turn the focus to the other units that are well-positioned for 2018/2019. Healthcare and Aviation are the no-brainers to mention but, as I described here, the Renewable Energy unit may eventually turn out to be a hidden gem.

So, the results and expectations for the Power segment are bad but they are not ugly.

The Ugly - Cash (or Lack There of) Is King

GE's cash flow concerns have been covered over-and-over again on Seeking Alpha so I will not spend too much time on the topic. However, it is worth noting that the company's cash generation issues are not as bad as one might think, especially given the poor stock performance caused by the concerns.

As shown, GE's cash from operating activities improved when compared to the prior year but let us also remember that there two main developments that could actually positively impact the company's cash flow prospects in the years ahead: [1] asset sales (i.e., receiving cash from the actual sales but also disposing of low-margin/underperforming assets), and [2] a shrinking pension deficit (for example, Bloomberg reports that GE's pension deficit is down 8% from 2016 and that each quarter-point rate increase cuts $2.4 billion from the company's pension obligation).

It is not a guarantee that the asset sales will be cash flow positive and GE already communicated plans to contribute $6B to the pension plan, but I believe that these two developments should bode well for the company over the longer term. Plus, the company will save ~$4B in 2018 due to the dividend cut.

Additionally, GE's balance sheet is not the complete disaster that many pundits would have you believe.

Even without factoring in the goodwill on the books, GE's has ~$290B in assets compared to $290B in liabilities. A smart asset sale or two, Healthcare for example, could completely change where this company is as it relates to leverage.

Bottom Line

Is GE a buy below $14 a share? Will Warren Buffett bail out the company again? Both of these questions are hard to answer but I will tell you how I plan to approach the stock. I am already long GE with an overweight position (around $22 per share) but I sold a 1/3 of my position in late 2017 for tax purposes. I do not believe that GE's stock will be a market beater over the next year but the company has some promising assets (e.g., Aviation, Healthcare, & Renewable Energy) that should help management change the narrative in late 2018/ early 2019. As such, I plan to monitor the good, the bad, and the ugly for GE and may look for an opportunity to put more money to work if shares continue their downward trend. I, however, do not plan to sell any more GE shares in the near future.

I do not like to tell investors to follow the big money, but I do believe that Mr. Buffett starting a stake in GE would mark a [near] bottom for the stock.

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.