Wall Street's most vociferous General Electric bear, J.P. Morgan's Steve Tusa, recently withdrew his $5 price target and declared he was more negative on the stock, citing free cash flow concerns. It would be a mistake to ignore Tusa and his concerns, because the highly-rated analyst has been an accurate forecaster on GE in recent years. In this context, let's take a look at what you need to know around GE's cash flow before buying GE stock.

General Electric is not a good value on current fundamentals

If you buy GE stock, you'd better be prepared to be patient. There isn't a strong case for buying GE in terms of its 2020 earnings and cash flow -- or even what the business will look like in one year's time.

Industrial conglomerates are often valued in terms of a price to free cash flow (FCF) multiple. FCF is the cash left from earnings after the change in working capital needed to run the business and capital spending are taken out. It contributes to the cash a company has available to pay down debt, pay dividends, and buy back stock.

General Electric's cash flow problems

The problem with GE right now is that the company is set to have a cash outflow in 2020. Even based on its likely 2021 performance, the stock doesn't look like a good value. Furthermore, Tusa is concerned about GE's lack of near-term FCF guidance and the company's reliance on GE Aviation for FCF. Meanwhile, GE Capital's most important business is its aircraft leasing unit, GECAS, which is also being hit by the slump in air travel. It never rains, it pours. 

Airplanes in flight.

GE needs air traffic to come back in order to boost aviation demand. Image source: Getty Images.

The following table of Wall Street consensus estimates puts things into perspective. As you can see below, General Electric looks very expensive relative to its projected 2020 and 2021 results. As a rough guide, a forward cash flow multiple of 20 times FCF or below is often seen as a good price. Furthermore, the consensus on GE's earnings and FCF may well prove overly optimistic. For example, the consensus on GE implies that the company will generate positive FCF in the second half of 2020 -- something Tusa doubts.

Company

2020 Consensus FCF

2021 Consensus FCF

2022 Consensus FCF

Management FCF Commentary

First Half 2020 FCF

Raytheon Technologies (NYSE:RTX)

$1.99 billion

$5.74 billion

$6.8 billion

FCF will be around $2 billion in 2020

$0.86 billion

Price to FCF multiple

45 times

16 times

13 times

N/A

N/A

General Electric (NYSE:GE)

($3.76) billion

$1.33 billion

$4.61 billion

Industrial FCF will turn positive in 2021

($4.28) billion

Price to FCF multiple

N/A

40 times

12 times

N/A

N/A

Honeywell International (NYSE:HON)

$4.53 billion

$5.36 billion

$6.2 billion

None

$2.05 billion

Price to FCF multiple

25 times

21 times

19 times

N/A

N/A

Data source: marketscreener.com, company presentations. Table by author.

GE's exposure to commercial aviation is particularly concerning. Raytheon generates 55% of its revenue from defense, while only around 25% of Honeywell's revenue comes from commercial aviation. In contrast, GE Aviation generated just $4.4 billion in sales to the military out of its total revenue of $32.9 billion in 2019.

GE Aviation produced $4.4 billion of FCF in 2019. That offset outflows at GE's power and renewable energy divisions, leading to total industrial FCF of $2.3 billion. Thus, GE is heavily reliant on commercial aviation for its FCF. That situation may change in the coming years as GE restructures its power and renewable energy units. However, for now, GE's FCF will largely be guided by aftermarket demand for GE's commercial aviation engines. 

As such, both Raytheon and Honeywell are arguably better values than GE on a risk/reward basis. However, that shouldn't detract from GE stock's attractiveness for long-term investors. After all, its earnings and FCF are set to improve notably from 2022 onward.

A longer-term perspective

There are three considerations that GE investors need to make regarding the stock.

First, it's perfectly understandable that GE hasn't given guidance for 2020. As you can see above, neither Raytheon nor Honeywell have given a lot of detail on FCF or earnings in 2020. There's a reason for this. Frankly, it's very difficult to predict where commercial aviation will go in the next few months. 

Indeed, Raytheon CEO Greg Hayes recently told investors on an earnings call that the commercial aerospace market "has proven to be a lot worse than what we originally projected even a few months ago." Given GE's heavy exposure to commercial aviation, it's hardly surprising that management declined to give guidance. Also, GE's original 2020 industrial FCF guidance of $2 billion to $4 billion was already very wide. Finally, GE's management started 2019 forecasting a cash outflow of up to $2 billion, only to end up generating positive FCF of $2.3 billion.

A clock in front of a pile of cash.

GE stock is not for the time-sensitive investor. Image source: Getty Images.

Second, as noted above, GE's earnings and FCF are highly sensitive to conditions in the commercial aviation market. In turn, near-term commercial air traffic will depend heavily on factors like travel restrictions, vaccine availability, and consumer sentiment. As such, making a long-term investment decision based on an estimate of where commercial air travel will be in the next few months doesn't make sense. 

Third, two of GE's four industrial segments (power and renewable energy) are in turnaround mode. Even before the pandemic struck, management didn't expect them to generate positive FCF until 2021 for power and 2022 for renewable energy. While those timelines have possibly been pushed back by the COVID-19 pandemic, GE should start to generate FCF from power and renewable energy in the future.

What it all means for GE investors

Anyone worried about the commercial aviation market's long-term future should avoid Honeywell, Raytheon, and GE shares: particularly GE stock. Similarly, Tusa may well be right that GE's near-term FCF estimates are too high.

However, management has the potential to turn around GE's power and renewable energy segments over time, and commercial aviation is still likely to recover gradually. As such, there is a case for buying GE stock, but it's only for investors willing to take a long-term view and ride out the inevitable volatility in the commercial aviation market.