General Electric: Change Is (Finally) In The Air
Summary
- General Electric reported mixed Q4 and full-year 2018 results but the stock finished the week higher by ~10%.
- Management was able to win over the market with their candor and, as it relates to GE's future state, I believe that change is finally in the air.
- I am long GE and have no plans to sell any shares, even after the recent run-up.
- This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Get started today »
General Electric (NYSE:GE) reported what I would consider mixed Q4 and Full-year 2018 operating results but the stock finished the week higher by over 10 percentage points.
Data by YCharts
GE shares reached the double-digit mark for the first time since October 2018, but I believe that the recent stock performance is only the beginning of a multi-year recovery (let me stress the word "year"). The Q4 2018 operating results, in my mind, were okay (at best) but I believe that the stock shot up in short order due to the fact that Mr. Larry Culp, CEO, was able to eliminate a great of uncertainty while showing the market that [real] change is in the air.
The Latest, Change Is In The Air
On January 31, 2019, GE reported Q4 2018 operating results that beat the top-line estimate ($33.3B vs $32.2B) but that missed the consensus earnings per share estimate (adjusted EPS of $0.17 vs $0.22). On a full-year basis, the company saw its top-line increase by 3% while its operating profit fell by 12%.
Source: Q4 and Full-year Earnings Press Release
Given the company's current state, those metrics sound good, right? However, as shown, it is the 'other things' that have plagued this once great company. The additional pension contributions and the insurance reserve charges were well-known but the goodwill impairments wrecked major havoc in 2018.
The company's quarterly results were already covered in great detail here on Seeking Alpha (see here and here) so I will not bore you by going over the same facts. Instead, I will focus on what caused the stock to jump - that is, the reality that Mr. Culp and team are focused on real change.
To me, the most interesting/meaningful/impactful slide in the deck was the summary of Mr. Culp's observations.
Source: Q4 and Full-year 2018 Earnings Presentation
The takeaways:
- Significant liquidity or, in my words, "don't worry about our liquidity position". Mr. Culp has been consistent with reassuring the market that GE is not in a dire position when it comes liquidity and I believe that the support behind his assertions is stronger now than it was a few months ago. Moreover, I believe that the $30B+ in asset separations will turn out to be a conservative estimate.
- The DOJ settlement is meaningful and it should not be overlooked, because this transaction alone eliminates a significant amount of uncertainty.
- Only time will tell with how the newly appointed leaders of the various business units will perform but I am also interested in seeing how the auditor tender process plays out. In my mind, change (and drastic change at that) is needed for this company and this may include the firm that has blessed what turned out to be very misleading (and this is putting it lightly) financials.
- Lastly, adding Paula Rosput Reynolds to the board brings in the type of expertise that is needed at this point in time, as I recently described here.
It was reported that Mr. Culp's candor sparked the stock rally. And while analysts are currently split on GE shares, I believe that Mr. Culp was able to support the thought that real change is finally in the air, which will go a long way toward improving investor sentiment.
If you asked me what really changed over the last week as it relates to GE and its future state, I would respond by saying, "a lot":
- Removed several major overhangs with the biggest example being the DOJ settlement.
- The company is so serious about de-levering the balance sheet - i.e., management laid out plans to reach the 2.5x industrial net debt/EBITDA target.
- The company officially took GECAS off of the chopping block, a topic that I recently discussed here. I see both the positive and negatives to this development.
- Disclosed plans to create an independent GE-owned digital business that will operate as a separate entity.
- Disclosed plans to consolidate the renewable and grid assets.
- The company is no longer hiding behind its numbers (this is strictly my opinion but you should be able to tell the difference if you listened to the conference call). When asked tough questions in the past, GE's management team consistently referred back to the results without providing the necessary color to investors and, in my opinion, Mr. Culp was transparent and detailed in his prepared marks. Moreover, I believe that management attempted to actually answer analyst's questions during the conference call instead of trying to skate around the tough ones.
And lastly, let's remember that Power is the problem right now - and it will likely be a problem in 2019, 2020 and possibly 2021 - but this industry is still a great business for GE to be in if you look out over the next few decades.
Valuation
GE's stock is attractively valued when compared to its peers.
Data by YCharts
To be clear, GE's stock deserves to trade at a steep discount to its peer group. If you are looking for a safe[er] investment in the industrial space, go with Honeywell. However, if you are willing to take on some risk, I believe that GE shares are attractively valued at today's price. Moreover, I believe that the asset separations (i.e., Healthcare, Transportation, and Baker Hughes (BHGE)) will act as catalyst for the stock.
Risks
Downside risks: (1) The company has significant additional fines related to the DOJ/SEC investigations, (2) Power takes longer than 18-24 months to recover and burns through cash, (3) management has a fire sale and disposes of assets at rock bottom prices, (4) the company's credit rating hits junk status, and (5) additional insurance reserve charges are booked.
Upside risks: (1) the spins [Transportation, Healthcare, and Baker Hughes] bring in more capital than anticipated, (2) the pension deficit shrinks as a result of the positive tailwinds, (3) well-known investors put money to work in GE which leads to a positive change in sentiment [e.g., Mr. Warren Buffett], and (4) Mr. Culp continues to win over the market.
Bottom Line
To clarify, GE is not yet in the clear and it probably will not be anytime in the near future. However, it is important to remember that the worst was being priced into the stock so almost any positive developments will go a long way. Example A: the recent earnings report.
It will take a long time to unpack GE's Q4 and Full-year 2018 results but, in my opinion, there is a lot to like about: (1) what was reported and (2) the direction that the new management team is taking this once great company. Simply put, Mr. Culp and team showed, or at least tried to explained that, GE's current state is really not as bad as some pundits would have you believe.
Hope is not an investment strategy so it is encouraging that there is a supportable investment thesis for this industrial conglomerate. GE is definitely still a 3- to 5-year story, but I believe that the stock is a great long-term investment, if it meets your risk/return profile.
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.