The prize ahead for General Electric (GE +2.19%) investors is significant if CEO Larry Culp can achieve his aim of generating margin improvements across all of its industrial businesses. In a sense, all GE needs to do is to get to the kind of margins enjoyed by its peers and the stock will have significant upside potential. Here's why.
General Electric and the sum of its parts
One way to value GE is to break out the businesses separately and try to compare them with what their direct peers trade on. To simplify matters, let's conservatively assume GE Capital (the company's finance arm) is worth nothing, and focus on its respective industrial businesses.
The central argument is that its peers in the renewable energy and healthcare sectors have higher valuations than GE's segments in recent times, and if GE can match their operational performance, then why shouldn't GE's business be valued on a similar level?
GE hopes renewable energy will provide growth opportunities for years to come. Image source: Getty Images.
For reference, it's important to compare like-for-like in such considerations, so it makes sense to compare enterprise value (market cap plus net debt), or EV, as it includes consideration for different amounts of debt held by the companies compared. GE's current EV is around $142 billion.
As ever with GE, the main focus is on free cash flow (FCF), so here's a look at recent FCF performance and 2021 guidance for the industrial businesses.
|
GE Industrial Segment Free Cash Flow |
2021 Guidance |
2020 |
2019 |
Closest Peers |
|---|---|---|---|---|
|
Power |
"Flat" |
0 |
($1.5 billion) |
Siemens Energy |
|
Renewable energy |
"Up and positive" |
($0.6 billion) |
($1 billion) |
Siemens Gamesa, Vestas |
|
Aviation |
"Up, partial recovery" |
0 |
$4.4 billion |
Raytheon Technologies |
|
Healthcare |
"flat to slightly up" |
$2.6 billion |
$1.2 billion |
Siemens Healthineers, Philips |
Data source: General Electric presentations.
GE Healthcare
GE Healthcare's principal activity is in imaging and ultrasound scanners, and its two key competitors in the marketplace are Siemens Healthineers and Royal Philips. That comparison has been strengthened following the disposal of GE's biopharma business to Danaher in 2020. As you can see below, both GE's healthcare peers trade on hefty valuations based on Wall Street analyst consensus.
The average of the estimated 2021 EV to FCF valuations is 27 times FCF. If GE Healthcare has another year of $2.6 billion in FCF (see table below), then the segment could be valued as being worth $70 billion in EV.
| Company Free Cash Flow /Valuation |
2019 |
2020 |
2021Est |
2022Est |
2023Est |
|---|---|---|---|---|---|
|
Siemens Healthineers free cash flow |
1.04 billion euros |
1.37 billion euros |
1.77 billion euros |
1.72 billion euros |
1.88 billion euros |
|
Enterprise value to free cash flow |
47.9x |
36.3x |
28.2x |
28.9x |
26.4x |
|
Philips free cash flow |
1.05 billion euros |
1.85 billion euros |
1.63 billion euros |
2.05 billion euros |
2.39 billion euros |
|
Enterprise value to free cash flow |
39.9x |
22.7x |
25.7x |
20.5x |
17.6x |
Data source: marketscreener.com. Author's analysis assumes current EVs throughout.
Renewable energy
To be clear, GE Renewable Energy is currently nowhere near the high-single-digit operating profit margins achieved by Vestas and Siemens Gamesa in recent years. In fact, the segment had a negative profit margin of 5.2% and a cash outflow in 2020. However, its best days are ahead of it as management continues to work through less profitable legacy contracts while focusing on improving pricing in cash flow generation. Indeed, Culp expects to generate FCF from GE Renewable Energy in 2021.
One way to value the segment is to compare its peers' EV to revenue and assume GE deserves a similar valuation in the future, provided it can match the margin and FCF performance of its rivals.
Data by YCharts
Using GE Renewable Energy's revenue of $15.67 billion, you could get to an EV of $32 billion to $35.5 billion. However, a more conservative assumption would be to use the estimated EV to revenue for Vestas and Siemens Gamesa in 2023 (the average is around 1.7 times) and then assume GE's profit margins are similar at that time. You can compare from there. Conservatively assuming that GE Renewable Energy grows revenue by 3.5% a year over that period produces an EV of around $30 billion for the segment.
GE Power
Siemens Energy (SMEG.F +3.49%) is a $26.6 billion market cap company combining a 67% stake in Siemens Gamesa and the former Siemens gas and power business. It has no significant debt. Given that Siemens Gamesa has a $25 billion market cap, the gas and power business is being valued at around $9.9 billion by the market.
GE hopes that the market for gas turbines will improve. Image source: Getty Images.
Based on the Siemens Energy gas and power revenue of around $21.9 billion in its fiscal 2020, the market is valuing it at 0.44 times sales. Taking that as a rough approximation for GE Power and its $17.6 billion in revenue in 2020 gives an EV of around $7.6 billion for GE Power.
What it all means for investors
Putting together these figures gives an estimated EV of $107.6 billion, and that's not even counting GE Aviation yet. It's no secret that it's going to take a few years for commercial air travel and engine demand to return to 2019 levels, but GE Aviation is surely worth significantly more than the $34.4 billion implied in this analysis.
A return to 2019 levels of FCF and a conservative valuation assumption of 20 times 2019 FCF for GE Aviation would put it on an EV of $89 billion. Altogether, that's an EV of nearly $200 billion for the industrial businesses compared to the current company EV of $142 billion.
To be clear, there's a lot of work to be done before GE Power and Renewable Energy get to peers' margins, and the recovery at GE Aviation is a multi-year event. However, it's also clear that a successful turnaround at GE could result in significant returns for investors.
