General Electric: It Ain't Goin' Be Easy

Summary

• General Electric needs to show some serious progress in its restructuring efforts, but a real turnaround is not going to be easy.
• However, I believe that General Electric's management team has levers to pull that should allow them to focus on the top risk factor (i.e., financial leverage).
• I am long General Electric and I plan to stay long.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

2018 will be a year that General Electric (NYSE:GE) and its shareholders will want to forget about. The company's stock started the year in the $17 per share range but GE shares are now sitting below $7, which are prices not seen since the Financial Crisis.

GE data by YCharts

This storied company's stock is down big over the last 11 plus months and this is after it finished down by approximately 45% in 2017. I have been asked a lot lately about what I plan to do with my GE shares and my answer has been consistent - i.e., I plan to stay long (and wrong, at least for now). My thoughts on this company/stock have not changed to this day, but it's important to remember, it is not going to be easy for Mr. Larry Culp, CEO, to orchestrate a true turnaround of this hodgepodge of a company. Therefore, investors should obviously still view this once great company as a high risk/high reward investment.

A Turnaround Is Needed ASAP, But It Ain't Goin' Be Easy

GE has had to contend with several major headwinds over the last two-plus years but the company's Power unit has consistently been the main topic of discussion for the bears. The table below puts the operating units' woes into proper context:

Source: Q3 2018 10-Q

It has indeed been that bad for Power. Moreover, the unit's profit margin dropped from the mid-single-digits to slightly above 0% for 2018.

Source: Q3 2018 10-Q

It would be the understatement of the year to say that the operating environment for Power was challenging over the first nine months of 2018. Management has been consistent with painting a picture of the challenges that Power is facing and I believe that investors should expect more of the same through at least 2019. The industry is being significantly impacted by overcapacity and it also does not help that GE has dealt with several self-inflicted wounds (i.e., multiple turbine issues).

Let's also not forget that the company had to recently take a $23B goodwill charge that was directly related to Power. It is going to take Mr. Culp and team time to turn around GE, but in my opinion, time is not on their side. I believe that Power is a multi-year problem so investors should definitely begin to bake in expectations that this operating unit will likely be a drag on results for the next few years, not quarters. Simply put, it ain't goin' be easy (please excuse my bad English) to turn around this conglomerate. However, as a long-term investor, it is important to remember that Mr. Culp and team have levers to pull that should allow them time to right the ship.

Levers To Pull

In my opinion, 2018 would have been a tough year for Power whether or not the Alstom assets were acquired; but the company's other issues added fuel to the fire at a time when GE was contending with way too many fires. To start 2018, shareholders had plenty of other things to be concerned about when it came to GE and its future prospects - cash flows issues, financial leverage, organic revenue growth (or lack thereof), the oil and gas industry pressures, pension deficit, insurance reserves, SEC investigations, and the list goes on. Today, however, I believe that many of these concerns are priced into the stock. To be clear, I think that the stock will remain under serious pressure if the SEC finds material issues or if additional insurance reserve builds are necessary, but in my opinion, the other items are already largely factored into GE shares.

Other than the insurance reserves and SEC investigations, investors should closely monitor GE's financial leverage through 2019 and beyond (as I previously discussed, I do not view liquidity as the real problem). While I do not fully agree with UBS analyst Steven Winoker's recent call on GE (12-month price target of $13), I do, however, believe that Mr. Culp and team have levers to pull to strengthen GE's financial position that should give them some much-needed time.

To this point, I believe that the Transportation, Healthcare, and [eventual] Baker Hughes (BHGE) spins should be welcomed news to shareholders. The Healthcare spinoff alone should be viewed as a significant portion of the investment thesis.

For the Healthcare spinoff, as it was recently reported, GE will likely IPO a more significant portion of this promising business. Based on my research, the standalone healthcare company could be worth anywhere in the range of $40B-$80B (some estimates are well north of $100B) and GE's total current market cap is under $60B.

Additionally, GE already announced that almost $18B of liabilities will go with the newly created standalone Healthcare entity (including some pension obligations). As such, the value that could potentially be unlocked by spinning off good businesses, coupled with the fact that a material amount of liabilities are likely going with the soon-to-be newly created entities, I believe that the spins could be major catalysts that will help GE strengthen its balance sheet.

Lastly, it now seems like spinning off some of Aviation, which is the company's prized asset, may actually be an option. I have said this several times before, but in my opinion, the reason to own GE now is due in large part to the upcoming spins.

Risks

Headline risk is taking over and, more specifically, the market listens any time JPMorgan's (JPM) 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

GE's next few years are going to be a tough period of time for this storied industrial conglomerate. But in my mind, a new company, in some form, will exit the current storm with a story to tell. The point that should be considered is, as shareholders, you will at some point own stakes in promising businesses (i.e., Transportation, Healthcare, and possibly Aviation) that will be able to operate without the GE overshadow. The NewCo is then just a lottery ticket.

It is impossible to hang your hats on the sum-of-the-parts estimates made today because there are way too many moving pieces, but it is hard to deny that standalone Healthcare and Transportation companies are worth owning.

GE is still a 3- to 5-year story so I will continue to hold onto my position, but in my opinion, I would avoid putting new capital to work in this industrial conglomerate until more is known about (1) the SEC/DOJ investigations and (2) the adequacy of the long-term care reserves. GE's other businesses are performing well, but I believe that the risk level for this industrial conglomerate continues to tick higher, so it is hard to get excited about the stock even after the recent pullback.

Lastly, the announcement that Ms. Paula Rosput Reynolds was appointed as a new board member is exciting/encouraging news. Ms. Reynolds previously held high-level management positions in two industries that really matter to GE, i.e., power generation and insurance. She was the CEO at Puget Energy Inc. and later served as the restructuring officer at American International Group (AIG). Her background is exactly what GE needs right now, so it appears that Mr. Culp understands the problem areas that need a fresh perspective.

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, 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.