It's understandable that value investors are taking a long hard look at General Electric (NYSE:GE) stock right now. The stock is down around 34% on a year-to-date basis, and despite the headwinds in the global economy, GE still has world-leading businesses in its portfolio.

But is it enough to make the stock a buy? Let's take a closer look.

GE and free cash flow

It's a good idea to break out General Electric's segments in order to see just where the profitability lies. Equally important is ascertaining where the potential for a swing in profits and free cash flow (FCF) comes from. For reference, GE's current market cap is $65 billion, so based on a price-to-FCF multiple of 20 times, GE needs at least $3.25 billion in FCF to start looking like a good value. 

Hand drawing circle of arrows around the words cash flow

Where's General Electric's cash flow going to come from? Image source: Getty Images.

This is especially important given that CEO Larry Culp recently divulged that the effects of the COVID-19 pandemic would send FCF into negative territory in 2020, compared to a previous forecast for $2 billion to $4 billion. The change in fortune comes largely from the severe challenges the coronavirus is causing GE Aviation.

GE Aviation is still the key

As you can see below, GE Aviation is the company's big cash flow generator. As soon it became clear that the coronavirus would affect aviation severely, it also became clear that GE's earnings/cash flow guidance would be under threat

General Electric free cash flow by segment.

Data source: General Electric presentations. *excludes the now divested biopharma business.

Healthcare

Putting GE Aviation aside for the moment, let's look at what to expect from the company's healthcare, power, and renewable energy segments in terms of engineering a swing in FCF.

Starting with healthcare, the fact is that the biopharma business sold to Danaher was the growth and cash flow engine of that segment. For example, biopharma contributed $1.3 billion of GE Healthcare's $2.5 billion in FCF in 2019.

As for the remaining healthcare business, on the investor call in March, GE Healthcare CEO Kieran Murphy said he expects the remaining healthcare business to grow at "low single-digit to mid-single-digit" after 2021 with "low single-digit sales growth" in 2020.

If FCF growth follows sales growth -- a reasonable assumption in a mature business like GE Healthcare -- then it could generate just $100 million to $200 million more in FCF by 2022, and figure on $1.3 billion to $1.4 billion in total revenue in 2022. Simply put, GE Healthcare is not really capable of significantly increasing cash flow that much.

A gas turbine.

End demand for gas turbines has been weak in recent years. Image source: Getty Images.

Power

Culp has started to engineer a turnaround in the power segment's margin, and the original plan for 2020 called for low-single-digit revenue growth in 2020 and 2021, with segment margin continuing to expand and FCF finally turning positive in 2021.

However, at a recent investment conference, Culp outlined that the headwinds created by the COVID-19 pandemic meant a return to positive FCF for power would take a bit longer than previously expected. The bottom line is that power is a low growth business at best, and FCF might not turn positive until 2022 now.

On a more positive note, low growth plus ongoing margin improvements to match the kind of mid-single-digit level achieved in 2017 could lead to $1 billion in profit and FCF over time. That would move the needle for GE -- note that power FCF was negative by $1.5 billion in 2019 -- but you are going to have to wait at least three years before seeing it.

General Electric Power

2017

2018

2019

Segment profit

$1.89 billion

($808 million)

$386 million

Revenue

$29.43 billion

$22.15 billion

$18.63 billion

Segment margin

6.4%

(3.6%)

2.1%

Data source: General Electric SEC filings.

Renewable energy

One of the reasons for the drop in GE Power revenue is that renewable energy is starting to be deployed as a source of electricity production, meaning there's less demand for GE Power's gas turbines. It's a transition that has hurt GE Power, but GE Renewable Energy hasn't taken advantage of the more favorable environment just yet.

Unfortunately, the outlook for renewable energy is similar to power. On the one hand, the original plan was for revenue to continue growing in 2020 and 2021 with margin improving to "break-even" in 2021, with FCF being better but still remaining negative. Of course, that's a lot better than the results in 2019, but just as with power, it's a multi-year recovery project.

General Electric Renewable Energy

2017

2018

2019

Profit

$728 million

$292 million

($666 million)

Revenue

$14.32 billion

$14.29 billion

$15.34 billion

Segment margin

5.1%

2%

(4.3%)

Data source: General Electric SEC filings.

What it means to investors

Let's put it this way: If you aren't bullish on the prospects of a recovery in commercial aviation, then you shouldn't be buying GE stock. The stock faces downside risk if the aviation market faces a multi-year stagnation.

Alternatively, if you are bullish on aviation, then there are plenty of other ways to invest in the thesis -- not least because GE investors can't rely on FCF contributions from power and renewable energy for a few years to come. Healthcare isn't going to improve FCF significantly, and investors might have to wait until 2023 before FCF turns positive for both power and renewable energy. 

Unfortunately, the COVID-19 crisis has altered the investment thesis at GE, and anyone investing in the stock is going to need a lot of patience before seeing the benefits of the turnaround in GE's FCF numbers.