General Electric (NYSE:GE) is scheduled to release its Q2 2018 financial results on July 20, 2018, and analysts are calling for this industrial conglomerate to report adjusted EPS of $0.17 on revenue of $29.7B. For comparison purposes, the company reported adjusted EPS of $0.28 on revenue of $29.5B in the same period of the prior year.
Anyone that follows GE should not be surprised by the expectations for this company to report a significant YoY decline in earnings but what I do find a little surprising (in a positive way) is the fact that some analysts are actually starting to tone down their bear cases for GE. For example, a notable GE bear, Deutsche Bank’s (DB) Nicole DeBlase, recently moved her GE rating from Sell to Hold. She wrote that GE is “taking bold actions to reshape/simplify the portfolio” and that the company’s stock is attractively priced based on her sum-of-the-parts valuation of $16.
There are plenty of reasons why I believe that GE is a buy-to-hold investment at today’s price but I am going to spend a few minutes talking about the upcoming catalyst that has the potential to unlock a tremendous amount of shareholder value in the years ahead – that is, the upcoming GE Healthcare spin-off.
Mr. John Flannery, CEO, and team recently disclosed their intentions to spin off GE Healthcare in what is being viewed as a direct attempt to unlock shareholder value.
Spinning off the healthcare division provides plenty of benefits to the parent company (i.e., reducing financial leverage, streamlining operations, etc.) but, in my opinion, the opportunity to own the standalone healthcare division should now be viewed as an important component of investors' investment thesis. The soon-to-be standalone company will take on approximately $18B in debt/pension obligations but GE Healthcare should have no issues servicing these liabilities.
As shown, GE Healthcare reported an operating profit of $3.5B on revenue of $19B in 2017 and, more importantly, the business unit is expected to see both top- and bottom-line growth in 2018.
Now, let’s look back to see how this unit has performed over the last five fiscal years.
|2017||2016||2015||2014||2013||Chg 17 to '13|
|Op Profit Margin||18.0%||17.3%||16.3%||16.7%||16.7%||8%|
Source: Data from GE's 2017 10-K
Observations from the table:
The financial results for GE Healthcare have not been spectacular by any means, but again, I believe that owning a standalone company in this industry will pay huge dividends (no pun intended) over the long haul. Moreover, GE Healthcare has had a strong start to 2018 as it recently reported double-digit growth in profit and a high single-digit increase in revenue for Q1 2018.
Source: GE's Q1 2018 Earnings Presentation
Plus, looking ahead, GE Healthcare finished the most recent quarter with a solid backlog and mid-single-digit growth in orders.
Source: GE's Q1 2018 Supplemental Report
Lastly, it is important to note that GE Healthcare was one of the few operating segments that reported strong organic revenue growth in the first three months of 2018.
I believe that investors should be encouraged about the prospect of eventually holding shares of GE Healthcare, especially if you consider the 2018 estimates (i.e., top-line and bottom-line growth of 3% and 5%+), the solid performance over the last five years, and the impressive Q1 2018 operating results (including the order numbers and backlog).
Additionally, GE Healthcare has dominant positions in several key categories and I have no doubt that this business unit will operate more effectively once it is outside of the GE portfolio.
Should investors stay long GE stock just because of GE Healthcare? No, but I do believe that the GE Healthcare spin will be a positive development for the soon-to-be 'new' GE, and it will also give current shareholders a position in a promising business that has great long-term business prospects.
It is hard coming up with a direct peer for GE Healthcare, so I included what I considered comparable companies (with help from this source). With that, let's attempt to come up with a potential market cap for GE Healthcare.
To start to think about a trading range, I created the table below based on the revenue and market cap numbers from these peer companies.
|Revenue||Market cap||X Revenue|
|Average (ex ILMN)||4.6|
Based on revenue, GE Healthcare has the potential to trade in the upper-$80B range.
On a forward price-to-earnings basis, the same healthcare companies are trading at well-above 20x earnings.
If GE Healthcare traded at 20x 'earnings' (conservative, and not a true apples-to-apples comparison), the total market cap would be in the $60B-70B range. Let's meet in the middle and say that GE Healthcare will have a market cap of $75B. Yes, both of these approaches are overly simplified but I believe that they shine a light on the fact that GE Healthcare makes up a significant portion of GE's current market cap ($121.5B as of July 12, 2018).
Not to get sidetracked, but let's now compare GE Healthcare to Thermo Fisher (had similar 2017 revenue and profit) just to see where this unit stands.
Source: Data from above (for GE) and Thermo Fisher's 2017 10-K
Thermo has a higher operating margin, so GE Healthcare definitely has some work to do. But, what I really want to focus on is a comment that I have heard several times over the past few weeks - i.e., GE Healthcare will be saddled down by the $18B in debt so there is no way that it will get an attractive valuation in the market. To this point, Thermo Fisher had over $20B in debt at the end of 2017.
GE Healthcare has a lower operating margin, and a slightly lower revenue figure, but the company will likely have a better net debt position than what Thermo Fisher had at the end of 2017. Therefore, the thought that GE Healthcare will be 'held back' by the ~$18B in debt/pension obligations is a bit misguided, at least at this point in time.
There is a lot to like about GE Healthcare and I believe that the soon-to-be-spun-off unit will be a market beater in the years ahead. There are plenty of people that are focusing only on the value that may potentially be unlocked during the spin-off, but in my opinion, the real benefit of the spin will be the opportunity to hold a position in GE Healthcare (outside of the industrial umbrella) over the next few decades.
For the 'new' GE, the leftovers (excluding Aviation) are hard to get excited about but the other transactions [e.g., Transportation and Baker Hughes, A GE Company (BHGE)] also have the potential to be catalysts for the stock. The Power division will likely negatively impact GE's operating results through 2019, and the SEC investigations will be an overhang until they get resolved, but I believe that the tide is slowly starting to turn for this company. GE already announced plans to focus on improving its financial leverage/pension deficit and Mr. Flannery has made some tough decisions to spin off/sell material businesses; so, in my opinion, this once storied company will have the opportunity to exit 2018 with a [somewhat] clean slate and be in a position to focus on returning to its industrial roots (pre-Immelt, of course).
As I recently described, investing in GE today is risky and there are a lot of moving pieces to factor in, but this industrial conglomerate has great assets/businesses in its portfolio if you are willing (and able) to hold onto your position for the next three to five years. As such, long-term investors should consider further pullbacks as buying opportunities.
Author's Note: All images were taken from General Electric's Investor Presentation, unless otherwise stated.
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.
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Disclosure: I am/we are long GE, BHGE. 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.