Having already plunged about 60% since the beginning of 2017, General Electric (GE +0.17%) stock began moving lower again last week after the company disclosed oxidation issues for its next-generation gas turbines. By Monday morning, GE stock had fallen to a new nine-year low around $11.60.
Obviously, it's unfortunate that General Electric will have to incur extra costs to fix the affected turbines and redesign components to improve their durability. That said, the struggling GE Power unit accounts for a small proportion of the company's value, so analysts and investors may be overestimating the significance of this incident. As a result, if GE stock continues to plumb new lows, it could create an attractive buying opportunity for long-term investors.
What happened
Last week, in a blog post celebrating the innovation of General Electric's power business, GE Power CEO Russell Stokes revealed that the company's new HA-class gas turbines were facing some teething problems. Stokes noted:
More recently, we identified an issue that we expect to impact our HA units. It involves an oxidation issue that affects the lifespan of a single blade component. Obviously, this was a frustrating development, for us, as well as for our customers. But we have identified a fix and have been working proactively with HA operators to address impacted turbines.
Four HA turbines have been shut down due to this oxidation problem, according to Reuters. Furthermore, GE expects the same issue to affect each of the 51 HA units that it has shipped, hence its speedy effort to find a fix and proactively replace the potentially faulty component across the whole HA fleet.
On Friday, GE acknowledged that the same oxidation problem may affect up to 75 9FB turbines (a different model), representing 1% or less of the company's global installed base of 7,500 gas turbines.
A disproportionate stock market response
GE stock has plunged by nearly 10% since the news about this faulty component first surfaced. This has knocked about $10 billion off the company's market cap. However, the cost to develop a fix -- which apparently took just a few weeks -- and roll it out across the small existing fleet will almost certainly be a small fraction of that amount.
Image source: General Electric.
Thus, investors seem to be viewing this setback as a harbinger of even worse things to come. Indeed, Stephen Tusa -- the most bearish analyst covering GE stock -- used this event to justify slashing his price target yet again, to a Wall Street low of $10.
Tusa described the incident as "a negative development for a company that has little wiggle room for more 'shoes to drop.'" He argues that GE Power faces company-specific issues, in addition to a structural downturn in the power market.
On the flip side, GE expects the affected Exelon turbine to return to service soon, despite the dramatic nature of the blade failure. Meanwhile, analyst Jim Corridore of CFRA Research described the HA turbine problem as "minor bad news." Thus, it's possible that Tusa's existing bearish stance has unduly colored his reaction to this event.
GE Power shouldn't be driving the stock's value
Over the past year or so, a series of disappointments in the power segment have driven numerous big drops in the GE stock price. Initially, the stock price declines made sense. As of mid-2017, investors had unrealistically high expectations for the GE Power segment's future profitability, due to a combination of misleading accounting at GE Power and a subsequent downturn in the market.
However, investors have knocked more than $150 billion off GE's market cap since early 2017, more than making up for the previous overvaluation of GE Power. As a result, GE stock now appears deeply undervalued.
As I noted last month, General Electric plans to spin off several major businesses by the end of 2019. The spinoffs could be worth $7 to $8 per current GE share, assuming oil services company Baker Hughes, a GE Company is included as a spinoff. Meanwhile, asset sales will substantially reduce GE's debt and pension liabilities.
At the end of this process, the remainder of GE -- consisting of the aviation, power, and renewables businesses plus a slimmed-down GE Capital unit -- would have a stronger balance sheet. Nevertheless, the implied value of this "future GE" is less than $5 per share.
This doesn't make much sense, given that GE Aviation is currently producing about half of the company's industrial segment profit and growing quickly. GE Aviation alone is worth far more than the implied post-divestiture price of GE stock.
In other words, GE stock is set to rebound in the coming years, even if GE Power turns out to be worthless. In the more likely case that GE Power is worth $2-$3 per share (a big markdown from its prior value), the upside for investors will be even greater.
