It takes around 365 days for the earth to rotate around the sun.
While that sentence is unlikely to win any literary awards, it does go a long way to explaining how investors think. Performance is measured yearly, and stocks are often valued simply on the basis of the one-year outlook for their key metrics; I'm not saying it's right, but that's the way it often seems to work.
Let's think about what a snapshot of General Electric (GE 8.28%) could look like in a year's time.
General Electric's prospects
The idea of taking a year-ahead snapshot is to consider what investors might be willing to pay for the stock in one year's time. The assumption is that the stock price could rise if the picture is more favorable then.
Image source: Getty Images.
There's a lot of evidence to suggest that GE will be in better shape a year from now. The table below shows the key issues within each industrial segment. As ever, GE's free cash flow (FCF) is in focus, a point I'll return to in a moment.
| General Electric Segment |
2019 Free Cash Flow |
How GE Looks in January 2021 |
How GE Could Look in January 2022 |
|---|---|---|---|
|
Aviation |
$4.4 billion |
Engine aftermarket sales are significantly down due to a collapse in commercial flights; engine orders are collapsing due to weak aircraft orders. |
The COVID-19 vaccine will act as a catalyst for a recovery in commercial flights and the market will start pricing in a long-term recovery. Aftermarket sales and engine orders will be on an uptrend. |
|
Healthcare |
$2.5 billion* |
Equipment orders are weak, with medical budgets prioritizing COVID-19 and elective surgeries delayed. |
Healthcare orders will improve, and the segment will continue to generate $1.2 billion or more in free cash flow. |
|
Power |
($1.5 billion) |
Both cost-cutting and a nascent recovery in margins are in progress. |
Gas turbine orders will recover from 2020; gas power fixed costs will be cut to $2.5 billion; power services and power segment margin will be on an uptrend. Positive FCF could return. |
|
Renewable Energy |
($1 billion) |
There's a nascent recovery in margins, and the company continues to work through low-margin legacy contracts. |
Margins will be break-even or positive, and on an uptrend. |
Data source: General Electric presentations. *Includes $1.3 billon from the now divested biopharma business. Analysis by author.
Putting it all together, it's clear that GE could look a lot better around this time next year. Indeed, Wall Street analysts are expecting a cash outflow of $1.26 billion in 2020 to turn to FCF of $2.75 billion in 2021.
Going back to the idea of a January 2022 snapshot of GE: At that time GE could look like a company with a clear line of sight to improvement in all four of its industrial segments (see the table above). Moreover, if GE meets analyst expectations, it will look like a company with a forward price-to-FCF multiple of 22.2 -- not a bad valuation for a company set for a multiyear expansion in earnings and FCF.
| Metrics: Analyst Consensus |
2020 |
2021 |
2022 |
|---|---|---|---|
|
Free cash flow |
($1.26 billion) |
$2.75 billion |
$4.51 billion |
|
Price to free cash flow |
N/A |
36.5 |
22.2 |
Data source: MarketScreener.com. Analysis by author.
Will General Electric get there?
Starting with aviation: It's almost impossible for anyone to accurately predict the recovery in commercial aerospace. However, we do know that COVID-19 vaccines are now helping to accelerate the natural process of herd immunity, and the evidence shows that growth in air travel is a function of how well regions are coping with the pandemic. The corollary is that commercial flights will return as the vaccine rolls out.
The chart below shows how flights in Asia improved while Europe struggled, in line with the relative performance of each region in controlling the pandemic.
Data source: RadarBox.com.
Moreover, the history of the commercial aviation industry suggests there's never really been a problem attracting capital into the industry, even when airlines haven't been great investments for equity investors. In addition, GE is receiving some support from its military engine orders:
Data source: General Electric presentations. *LEAP engine orders are included in commercial engine figures.
GE's healthcare businesses tend to be solid performers, and healthcare orders should improve in due course. Meanwhile, investors were pleased to see positive segment margins in power and renewable energy in the recent third quarter.
In particular, note that renewable energy appears to be progressing well. For example, back in March management had forecast that the renewable energy segment's profit margin would be "breakeven" in 2021, but given that it was 0.1% in the third quarter of 2020, investors have reason to believe GE could exceed that target. Moreover, management estimates that it will only have $1.5 billion in backlog from low-margin pre-2016 deals at the end of 2020, compared to $5 billion at the start of 2020.
Data source: General Electric presentations.
General Electric in one year's time
All told, there's a strong case for arguing that GE will look a lot better this time next year. Of course, a lot can happen in a year, and investors need to try and price in the risk that global growth and/or commercial aviation markets don't recover as expected.
All told, GE isn't quite the excellent value stock it looked like a few months ago. But if you're optimistic about commercial aviation and about CEO Larry Culp's ability to turn around the power and renewable energy businesses, then there's still a case for arguing that GE is a good value.
