The short answer is General Electric (GE 3.94%) will almost certainly be in a better place in the next five years. However, that doesn't necessarily mean the stock is a buy right now, because a lot of things need to go right for the company to be a good value. Let's take a look at what GE could look like in a few years' time.
General Electric's free cash flow
GE is a company with four separate industrial businesses and a capital arm whose main value lies in an aircraft leasing business, GE Capital Aviation Services (GECAS). GE Capital's business and finances are hard to understand. So lets put it aside for now and look at each industrial business in isolation in order to see where the company could be in a few years.
Investing in General Electric stock is only for the patient. Image source: Getty Images.
The following table provides a snapshot of how the businesses could start to look like in a couple of years and thereafter. The analyst consensus for $3.5 billion in free cash flow (FCF) in 2022 would put GE on 16.9 times FCF in 2022 -- an attractive valuation, but the key question is can GE get there?
|
General Electric Segment |
2019 Free Cash Flow |
Management's Aims for 2022+ |
|---|---|---|
|
Power |
($1.5 billion) |
GE Power will get back to high single-digit earnings/FCF margin and start to generate FCF again |
|
Aviation |
$4.4 billion |
GE Aviation will recover in line with commercial aviation, and its engines will generate highly lucrative aftermarket sales for years to come |
|
Renewable energy |
($1 billion) |
Margins will get back on track for high single digits in line with peers, and the bet on offshore energy will start to payoff |
|
Healthcare* |
$1.2 billion |
Steady low to mid-single-digit growth in earnings/FCF |
|
Corporate & Eliminations |
($2.1 billion) |
Cost cuts will lower outflows as CEO Larry Culp engineers productivity improvements |
|
Total GE Industrial* |
$1 billion |
Wall Street analysts are projecting $3.5 billion in total company FCF |
Data source: GE presentations. Author's analysis. *Healthcare FCF excludes the now divested biopharma business.
Power
The power segment lies at the heart of the industrial company's problems in recent years. Unfortunately, the heavy-duty gas turbine equipment market has halved in the five years since 2015, partly down to the shift toward the use of renewable energy as a source for electricity production. It's a fact that makes GE's purchase of Alstom's power and grid assets in November 2015 look like a very bad idea.
The deal was supposed to consolidate the industry and allow GE to add its digital capability to Alstom's power solutions. Instead, it lumbered GE with unfavorable contracts at the point when end demand was collapsing.
No matter, GE chief executive officer Larry Culp is overseeing an ongoing improvement in margin as GE Power works through unfavorable legacy contracts. As such, FCF is expected to turn positive somewhere in the 2021/2022 time frame.
| General Electric Power Segment |
2017 |
2018 |
2019 |
2020 Management Outlook |
2021 Management Outlook |
|---|---|---|---|---|---|
|
Revenue |
$29.4 billion |
$22.1 billion |
$18.6 billion |
Low single- digit growth |
Flat to low single-digit growth |
|
Segment profit |
$1.9 billion |
($0.8 billion) |
$0.4 billion |
Expanding |
Expanding |
|
Segment profit margin |
6.40% |
(3.60%) |
2.10% |
Expanding |
Expanding |
Data source: General Electric presentations.
As such, a combination of low single-digit growth and a return to mid-single-digit profit and FCF margin could see GE generating at least $1 billion in FCF in five years' time.
Healthcare
Probably the most reliable, but unexciting, of GE's businesses, healthcare is set for low to mid-single-digit growth in earnings and cash flow over the next few years. Given that, excluding the now divested biopharma business, the segment generated just $1.2 billion in FCF in 2019, it's reasonable to assume GE Healthcare will be generating something like $1.3 billion to $1.45 billion in FCF in a few years' time.
Renewable energy
Renewable energy is arguably the most interesting of GE's business. Culp is trying to engineer a turnaround in renewable energy margin in its onshore wind power business while hoping the company's bet on offshore wind energy pays off. Culp hopes to eventually achieve the high single-digit margins enjoyed by its peers like Vestas and Siemens Gamesa.
| General Electric Renewable Energy Segment |
2017 |
2018 |
2019 |
2020 Management Outlook |
2021 Management Outlook |
|---|---|---|---|---|---|
|
Revenue |
$14.3 billion |
$14.3 billion |
$15.3 billion |
Low single-digit growth |
Up |
|
Segment profit |
$0.7 billion |
$0.3 billion |
($0.7 billion) |
Negative |
$0 |
|
Segment profit margin |
5.10% |
2% |
(4.30%) |
Improving, but still negative |
Breakeven |
Data source: General Electric presentations.
Similar to GE Power, if Culp achieves his aim of mid-single digit margin, GE Renewable Energy could be generating $1 billion in FCF in five years' time, However, it may well have a better long-term growth profile than the power segment, particularly if offshore wind orders take off.
Image source: Getty Images.
Aviation
There's no way to avoid the fact that the COVID-19 pandemic has significantly impacted the commercial aerospace market, and in turn GE's near-term prospects. The market will surely recover, but over what kind of time frame?
Industry insiders like Raytheon Technologies CEO Greg Hayes are expecting it will take at least two to three years before commercial aerospace returns to 2019 levels. If so, it's reasonable to expect GE's 2019 GE Aviation FCF to return to the $4.4 billion level over that time frame, too. Meanwhile, GE Capital's prospects are also largely dependent on commercial aerospace through its reliance on GECAS.
Looking ahead
Putting it all together, it's not unreasonable for GE to be generating industrial FCF in the $6 billion to $7 billion range in five years. Those figures would put GE on a price-to-FCF multiple in the high single digits.
If you believe Culp can turn around margins at power and renewable energy, healthcare will remain in solid growth, and aerospace will make a gradual recovery, then GE could be a very good value. Clearly, a lot of things need to come together for GE; nevertheless, there is a case for buying the stock for very patient investors.
