Thoughts On General Electric Heading Into 'Judgment Day'

Summary

• General Electric plans to release Q3 2018 results at the end of October and the company's new CEO will take center stage.
• I will describe in this article the topic(s) that I would like to hear more about from the new CEO.
• I am long General Electric and I plan to stay the course.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

As most people already know, General Electric (NYSE:GE) recently pushed back its Q3 2018 earnings release date from October 25 to October 30, 2018 and many analysts are nervously awaiting what the results/commentary may bring. The exact reason for the rescheduled release date is not fully known, but the company let investors know that the extra time would "allow GE Chairman and CEO Larry Culp to complete business reviews and site visits". The company also disclosed that Mr. Culp would share his initial observations of his review in October 2018 and will provide additional details in early 2019.

Anyhow, currently the important thing to highlight is the fact that GE's stock has given back almost all of its gain that it saw from the CEO change announcement.

GE data by YCharts

In this article, I do not want to waste your time trying to guess what may happen when the company's new CEO speaks about GE's future state for the first time but, instead, I will spend a few minutes covering what I will be interested in hearing about later this month.

A Change In Strategy? What Is Really Going On With Power?

Mr. Culp will only have been CEO for about a month when GE reports Q3 2018 results, but, in my opinion, it should not take much time for the board and the current management team to describe what is really going on with Power. The old CEO, Mr. John Flannery, consistently referred to Power as a multi-year turnaround story, a point that I fully believe to be the case, but I am really interested in hearing Mr. Culp's initial thoughts about the Power unit's medium-to-long-term prospects. So far in 2018, this operating segment has been nothing short of a disaster.

Source: Q2 2018 Earnings Presentation

Again, I do not expect for Power to recover anytime soon, but I do want details on the management's go-forward plans. Several pundits have floated the idea of GE spinning off Power, but I believe that this unit should remain a part of GE's business portfolio. Looking out, Power remains a viable business (and that is being conservative) as demand is expected to remain strong in the years ahead.

Source: EIA, 2018 Outlook

This is the reason why I think that investors should look past the current Power headwinds because, at the end of the day, this operating unit still has promising long-term business prospects. Are changes needed? Yes, but I believe that Power should continue to be apart of the "new" GE.

Let's also remember that the SEC is still reviewing GE's "aggressive" accounting related long-term Power service agreements so, in my mind, additional clarity (i.e., a settlement or closure of the case) would do wonders for a company that is dealing with a lot of uncertainty.

So, when GE reports Q3 2018 results, the first thing that I want to hear is management's thoughts on the Power unit. After that, any update on the SEC investigations would be welcomed news.

The Bears Are Raising Some Valid Concerns

The most well-known GE bear, JPMorgan's J. Stephen Tusa, released another investor note and raised concerns about the industrial conglomerate's financial leverage. Another bear, Gordon Haskett's John Inch, warned investors that GE could still owe billions more for the old insurance contracts.

These two gentlemen have been on point time after time over the last two years when it comes to evaluating GE so, in my opinion, management needs to address these concerns sooner rather than later or the stock will likely remain under pressure.

Looking Out, Is It Really That Bad?

Starting with management, I believe that Mr. Culp is the right guy for the job. Mr. Flannery did what he had to do (i.e., change course and be the fall guy), but Mr. Culp has the experience that should allow him to right the ship in somewhat of an orderly manner. Moreover, I am not the only person that thinks that Mr. Culp is the right guy for GE. As recently described in this MarketWatch article, Mr. Culp has a knack for improving a businesses from the inside out (i.e., focusing on internal business processes and fundamentals), which is exactly what GE needs at this point in time. However, only time will tell if Mr. Culp was a good choice.

When it comes to GE's business prospects, the read-throughs from the results of Honeywell (HON), United Technologies (UTX) and Boeing (BA) is that Aviation remains to be a great business to be in. This operating unit alone is something to brag about.

In a broader context, the backdrop remains strong for industrial companies. According to recent readings, the U.S. economy grew at a faster than expected rate in Q3 2018 (an annualized rate of 3.5% vs. the expected 3.3% rate). While the current rate is below the impressive 4.2% rate posted in Q2 2018, the 3.5% rate supports the case that the economy is on good footing. GE will go as the economy goes (well, after the company's current issues are resolved) so the strong GDP number is encouraging news.

Additionally, according to Fidelity's recent sector rankings, industrial companies score well in the Business Cycle scorecard indicator.

Source: Fidelity

A strong (and improving) backdrop is not enough to prop up GE's stock, but it is definitely positive news. It is hard to get too excited about GE today, but I believe that there are legitimate reasons to stay the course.

Valuation

MarketRealist recently published their analysis of GE's current valuation when compared to peers.

Source: MarketRealist

As shown, GE is not as cheaply valued as you might think, especially on a forward EV/EBITDA basis. However, as I recently described, GE is not priced for perfection either, so the stock should face upward pressure once the numerous issues are resolved.

Risks

Headline risk is taking over and, more specifically, the market listens any time JPMorgan's Tusa talks about GE, and rightfully so. And more broadly, investor sentiment is the key driver of GE's stock and it will likely be for the foreseeable future, so I would pay close attention to what the Street has to say about the prospects for this storied company. Remember, analysts can be wrong (and they are a lot of times), but it seems like the market hangs onto any of the GE bear stories that get floated in today's environment.

Bottom Line

The market is in correction territory, so the most likely direction for stocks, at least in the near term, is down, but looking out, I believe that GE will soon be properly positioned for the decades ahead. Remember, the Power concerns are short- to intermediate-term headwinds.

GE remains a 3-to-5 year story, but I do believe that the risk levels for this conglomerate have continued to increase over the last 12 months. Therefore, GE should be viewed as a high risk/high reward investment (approaching the 'bet' threshold) that will need time for the story to play out.

I plan to stay the course with my GE position, what do you plan to do?

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, HON, UTX. 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.