The General Electric logo at the top of their global operations centre, on Jan. 16, 2018, in the Banks development of downtown Cincinnati.John Minchillo/The Associated Press
General Electric (GE – NYSE) has undergone a huge metamorphosis through the years, with the past five under chairman/CEO Lawrence Culp being particularly dramatic. His goal was to simplify the company, and that he has done. Under his watch, revenues dropped from just under US$100-billion to US$76-billion last year – and not all of that was because GE got rid of its 129-year-old light bulb business! The stock price – Benj paid US$124.48 (adjusted for a 1-8 stock consolidation) – was almost always underwater, even with the shares received in a spinoff of GE HealthCare Technologies Inc. (GEHC). Alas it still is, currently trading at around US$110, but the market cap has been exploding, doing better than a double in less than a year. With an initial sell target of US$234.24, we feel there is lots of upside left in store.
How might the price get there? First, orders are up 59 per cent from one year ago. The bottom line jumped 89 per cent, and more is expected as the EPS estimate has shimmied from US$1.70 to US$2.00 to between US$2.10 and US$2.30. Revenue growth that was expected to be in the high single digits is now estimated to be in the high teens to 20 per cent. Free cash flow is forecast to a range of US$4.1-billion to US$4.6-billion, up from US$3.6-billion to US$4.2-billion.
General Electric is also gathering cash via spinoffs, with 32 per cent of the aforementioned GE HealthCare being dumped at the beginning of this year for US$2.2-billion. The energy business, GE Vernova, will likely be spun off for additional billions of dollars – the current estimate is US$13-billion – leaving an aviation-focused business. Mr. Culp recently said, “We’re increasingly operating as GE Aerospace and GE Vernova as we prepare to launch these two independent companies sometime in early 2024.” While that could be wonderful, investors should remember that the aerospace industry is highly cyclical.
What to watch out for when investing in spin-offs
Over time we expect the friendly skies to become more and more crowded as people from poorer countries gain a footing and commence flying. In addition, people from richer countries are continuing to do “travel catch-up” after being stuck at home because of COVID-19. That should lead to more demand for GE’s aircraft engines, and we suspect that revenue and profit will grow by double digits. The company cited increased demand in the aerospace segment and record renewable energy orders.
Meanwhile, defence should also help fatten the stock price, with orders doing better than a double. Engine output will grow handily, as orders are up 74 per cent year-over-year. Still, even with all the positives, investors considering this stock should note that the book value is less than $29, which should give buyers pause.
Of course, a huge question going forward is the global economy, that macro environment thing. Attitudes have dramatically shifted, with a huge cross-section of “experts” calling for a recession steadily for the past year. Now pundits are backing off that call. To be fair, our conviction was also that a downturn would already be upon us, and the conclusion quite simply is that we were wrong. Yes, we can admit that. Still, our Spidey senses suggest it is not far away.
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General Electric is the oldest holding in the Contra portfolio, acquired in 2010. Ultimately it would have been wise to take a tax loss years ago and then repurchase it. Alas, that was not done. At this point it appears like the long wait may finally be rewarded. Still, with the sell target so far away, it will likely take numerous years, with the hope that patience will once again win out. Right now, strong momentum looks to be our friend. In addition, the dividend, which was a quarterly penny as recently as 2021, has been increased to eight cents a quarter. In all likelihood, this will at least double in the next few years, offering an additional return on the investment.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter.