General Electric: What the Bulls Are Missing

Like a lot of investors, I had high hopes for General Electric (GE +1.61%) when I bought shares a little over a year ago. But then the other shoe dropped (or, rather, the other dozen or so shoes kept dropping and dropping and dropping), and it quickly became clear that the picture at GE wasn't anywhere near as rosy as the company had been leading people to believe.

Fast-forward through a (painful, for investors) year of dividend cuts, insurance charges, writedowns, lowered guidance, asset sales, and a CEO exit, and here we are. I still think things look pretty dismal for GE, but plenty of people think I'm wrong.

In fact, some analysts believe that GE -- now trading at about $7.50/share -- has finally hit an attractive valuation. Here's what they're missing.

General Electric has been punished by the stock market for its recent underperformance. Can it bounce back? Image source: Getty Images.

The sum of its parts

GE is currently made up of one incredibly strong division (GE Aviation, which makes aircraft engines), one strong division (GE Healthcare), and a few duds, including its low-margin consumer lighting business, its small renewable-energy unit, and its flagship GE Power, whose declining sales have been the cause of much of the conglomerate's headaches. GE also owns a 62.5% stake in Baker Hughes, a GE Company (BHGE +0.41%).

GE bulls suggest that from a valuation perspective, if GE were to be broken up completely and sold off piecemeal, shareholders would more than recoup their money, given today's share price -- which translates to a market cap of just over $65 billion. If that's the case, GE could be considered undervalued, or even a major bargain. Let's do a quick valuation of GE's major assets so you can see the bull case. 

Adding it all up

GE's stake in Baker Hughes is probably the easiest asset to ballpark. With Baker trading at about $23 per share, GE's stake is worth about $15.8 billion. 

GE and its shareholders are also set to receive 50.1% of the shares of the new Westinghouse Air Brake Technologies (Wabtec) as part of its merger with GE Transportation, which should close in early 2019. GE shareholders will also receive $2.9 billion in cash from the transaction. It's tough to know exactly what that stake will be worth in the end. But, conservatively, if we just look at Wabtec's current market cap of about $8.4 billion, half of that plus $2.9 billion in cash equals $7.1 billion.

Moving on to GE Healthcare, perhaps the best thing to do is to look at the current valuation of its smaller rival, Siemens Healthineers, which currently has a market cap of about $42 billion. Healthineers was recently spun off from Siemens, so an apples-to-apples comparison is tricky, but it seems to have slightly less annual revenue than GE Healthcare -- about $16.1 billion compared to the $19.1 billion that GE Healthcare reported in 2017 -- and far less net income ($1.6 billion compared to the $3.4 billion that GE Healthcare reported in 2017). Let's give the bulls the benefit of the doubt and assign a value of $84 billion (double Healthineers' value) to the twice-as-profitable GE Healthcare. 

The big prize, of course, is GE Aviation, which is even stronger than GE Healthcare, and ought to be worth more: some estimates put its value at $100 billion. Let's use that figure, and assume that the low-margin consumer lighting business, the collapsing GE Power business, the middling renewable energy business, and the company's troubled financial arm, GE Capital, aren't going to be worth much when all's said and done (.

Add it all up and you get $206.9 billion: about three times higher than GE's current market cap of $65 billion. But here's the thing: this simple analysis ignores a major red flag...or, should I say, a red-ink flag.

Drowning in debt

It's not enough to just look at GE's assets when valuing the company. You also have to look at the company's liabilities, and they are substantial. Here are some of the liabilities listed on GE's most recent balance sheet from Q3 2018:

Data source: General Electric Q3 2018 10-Q, p. 68. 

Yikes. Between short-term debt, long-term debt, investment and insurance liabilities, and underfunded pension obligations (the "non-current compensation and benefits" line), GE has a mountain of red ink on its balance sheet. And then there's the $37.8 billion in "other" liabilities that we have no idea what it consists of. These liabilities alone are higher than that $206.9 billion we estimated as GE's value. 

The bulls would point out that GE also has $26.9 billion in cash on its balance sheet, and that as interest rates go up, unfunded pension obligations should go down. But even if the company could cut its unfunded pension obligations line in half, and if we factor its cash-on-hand into our valuation, we still get a value of $233.8 billion against $202.8 billion in debt, yielding a net value of $31 billion, less than half of GE's current $65 billion market cap. 

That's hardly a bull case. 

No bull

So, from a valuation standpoint, GE -- even after its 75% stock price slide over the past three years -- doesn't look like much of a bargain. In fact, things may be even worse than I outlined above: just because these seem to be reasonable valuations doesn't necessarily mean that's what GE would fetch for those assets in a sale. In fact, if GE is looking to sell these assets quickly to raise cash, it may have to accept whatever discounted price it can get. 

Plus, GE has a history of unearthing surprise liabilities -- like the unforeseen $6.2 billion insurance charge it incurred in late 2017 -- which means that even more of its value may already be spoken for. Lastly, once assets are sold, they don't generate cash flow for the company, which means it may be even harder for the company to rid itself of debt.

The bottom line is that investors looking for bargains would be better off looking elsewhere.