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GE's Industrial Debt Will Balloon in 2021, but the Stock Is Still a Good Value

By Lee Samaha - Mar 24, 2021 at 7:22AM

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Two reasons why the recent outlook meeting was a lot more positive than many thought it was.

The market didn't take too well to General Electric's (GE 2.37%) recent investor-outlook presentation, and sold-off the the stock by a double-digit percentage in the days afterward. While it's impossible to know the reason why, it's likely that the deterioration in the outlook for the company's reported industrial debt was a large part of it.

However, the devil is in the details, and upon closer inspection, GE is actually well placed to reduce its debt and be a good value stock. Here's why.

General Electric's guidance

Having already outlined GE's debt plans on the investor day on March 10, GE's CFO Carolina Dybeck Happe outlined them again a week later at the Bank of America Global Industrials Conference on March 17. Clearly, GE wanted to get the message out again, as it's fair to say that the presentations may have led to some confusion. Let me try and unravel them for you.

An aircraft engine being serviced.

GE is hoping the commercial aviation market recovers in due course. Image source: Getty Images.

On a headline basis, GE's industrial debt guidance was terrible. As you can see below, industrial debt is set to rise by $21 billion, with net debt rising by $19 billion from 2020 to 2021. It's all expected to result in the all-important net debt to earnings before interest, taxation, depreciation, and amortization (EBITDA) ratio of six times. Considering that investment-grade debt (seen as having a low risk of default) is usually 2.5 times or below, these numbers look very disappointing.

General Electric

2021 Estimated

2020

Industrial debt

$70 billion

$49 billion

Cash

$25 billion

$24 billion

Industrial net debt

$51 billion

$32 billion

Net debt to EBITDA

6 times

5.9 times

Data source: General Electric presentations.

However, before you rush to hit the sell button, I have two key, game-changing considerations from the presentation.

General Electric's debt-reduction plan adds up

First, the reason why industrial debt is set to balloon is that the GE Capital businesses remaining after the deal to sell its aircraft-leasing business GECAS to AerCap will now be transitioned to GE Industrial. As such, GE will now report as a normal industrial company. Indeed, management lauded the transparency in clarity in reporting in one accounting line (GE), as opposed to three lines (GE Industrial, GE Capital, and Consolidated).

Investors shouldn't panic about a change in accounting. Instead, the key thing they should focus on here is GE's debt reduction plan for 2023. So here it is.

The key number is the $25 billion in debt reduction to $45 billion (more on that in a moment). Equally important is the net debt-to-EBITDA ratio. It's intended to be below the key 2.5 times figure in 2023.

For reference, the generally accepted debt-to-EBITDA ratio for investment-grade debt is 2.5 or below. That would be a remarkable turnaround for a company that some investors feared could go bust a few years ago.

General Electric

2023 Estimated

2021 Estimated

Industrial debt

$45 billion

$70 billion

Cash

$10 billion to $15 billion

$25 billion

Industrial net debt

$33 billion to $37 billion

$51 billion

Net debt to EBITDA

$2.5 times

6 times

Data source: General Electric presentations.

Turning back to the $25 billion debt-reduction plans, Dybeck Happe said GE had potential cash from the sale of its remaining stake in Baker Hughes (worth around $7.5 billion by my calculations) and a stake in AerCap, valued at $6 billion by GE. Also, Wall Street analysts are forecasting GE will generate $15.5 billion in free cash flow over the three year period, from 2021 to 2023.

Put together, the $15.5 billion in free cash flow plus equity stakes worth around $7.5 billion (Baker Hughes) and $6 billion (AerCap)  total $29 billion. Provided the stock market and the economy don't turn sour, GE will have ample resources to achieve its aim of a $25 billion reduction in debt by 2023.

Implied EBITDA guidance is very good

Second, observant readers will have noted that GE's management gave net debt targets for 2021 and 2023 and net debt-to-EBITDA targets for the same period. From this, it's a matter of simple mathematics to conclude that GE's implied target for EBITDA in 2021  is $8.5 billion, and the implied target for 2023 is $13.2 billion to $14.8 billion.

Wind turbines.

GE is a major player in wind power. Image source: Getty Images.

To be completely clear, Dybeck Happe didn't say this was specific guidance and intimated that it was more about giving investors an example. However, investors are entitled to read between the lines, and the fact is, those EBITDA figures are significantly ahead of the Wall Street consensus for EBITDA of $7.6 billion in 2021 and $13.1 billion in 2023.

Of course, to get to this kind of EBITDA figure in 2023, GE is going to need its power and renewable energy businesses to improve margin. Also, the aviation segment needs to get back to the kind of $6.8 billion in profit it generated in 2019 rather than the $1.2 billion reported in 2020.

Hitting these EBITDA figures has two consequences. It means analysts may need to upgrade earnings expectations and GE might generate more free cash flow (FCF) than the previously expected $15.5 billion figure from 2021-2023 that I referred to above. This would make the debt-reduction plans easier.

Looking ahead

All told if GE hits its debt-reduction plans, $13.2 billion to $14.8 billion in EBITDA, and its stated aim of high-single-digit FCF margin in 2023, it will be a company with investment-grade debt trading at around 17 times FCF in 2023. That's attractive for a company with a multi-year growth opportunity. That's the key takeaway from the recent investor meetings.

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Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
GE
$76.40 (2.37%) $1.77
AerCap Holdings N.V. Stock Quote
AerCap Holdings N.V.
AER
$48.20 (6.19%) $2.81
Baker Hughes, a GE company Stock Quote
Baker Hughes, a GE company
BKR
$35.16 (0.66%) $0.23

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