General Electric (GE 1.12%) has been slowly winning over investors and analysts in 2021. Indeed, Citibank's Andrew Kaplowitz and UBS' Markus Mittermaier have slapped a buy rating and a $17 target on the stock. Moreover, given management's recent commentary and guidance, there's a good case that GE is undervalued. Let's take a closer look at what GE stock could be worth in a few years.
General Electric's valuation
The case for GE is one built on comparing the sum of the parts of GE's industrial businesses and comparing them with what its peers trade at.
The guiding metric in all of this is enterprise value (EV), which is simply GE's market cap plus its net debt. On the company's investor update in March, CFO Carolina Dybeck Happe outlined plans to reduce GE's net debt from $51 billion at the end of 2021 to $33 billion to $37 billion in 2023. With these numbers in mind, you can then work out a market cap valuation from an estimated EV by stripping out the net debt.
General Electric's enterprise value
One way to cobble together an EV estimate is to look at each industrial business and compare it to its peers. This is an interesting exercise, because GE has two businesses -- GE Healthcare and GE Renewable Energy -- in sectors that are commanding high valuations at the moment.
Starting with healthcare, GE's two major rivals in imaging and ultrasound are Siemens Healthineers and Royal Philips. The analyst consensus EV-to-free-cash-flow (FCF) 2023 valuations for these two companies are 23.9 times FCF and 21.1 times FCF, respectively, averaging 22.5.
Turning to GE Healthcare, the business produced $2.6 billion in FCF in 2020, and management is guiding toward "flat to slightly up" and "flat to up" for the next couple of years. Conservatively assuming GE Healthcare is generating at least $2.7 billion in FCF in 2023 would put the business at an EV of around $61 billion in 2023.
Valuing GE Renewable Energy is somewhat more difficult because the business is only set to turn into an FCF generator in 2021. However, management aims to get the business to the high-single-digit profit margins enjoyed by its peers Siemens Gamesa and Vestas. GE's management expects to get there by growing its offshore wind business revenue from $200 million in 2020 to $3 billion by 2023. Meanwhile, the onshore wind, grid solutions, and hydropower businesses are forecast to improve their margins as the company works through unfavorable legacy contracts.
Analysts have Siemens Gamesa and Vestas trading at an average EV-to-revenue figure of 1.57 times revenue in 2023. Based on this figure and GE growing revenue at a mid-single-digit pace to around $18.2 billion in 2023, GE Renewable Energy could be given an EV of $28.5 billion in 2023.
Power and aviation
GE Power's main competitor is the gas and power business of Siemens Energy. For reference, Siemens Energy is a company combining a 67% stake in Siemens Gamesa and the former Siemens gas and power business. Based on the 17.6 billion euro market cap of Siemens Gamesa and the Siemens Energy market cap of 18.1 billion, the gas and power segment is currently valued at 6.2 billion euros.
Siemens Energy aims to get its gas and power earnings margin up to a range of 6%-8% in 2023. That's the sort of figure that GE Power is aiming for too, so it's fair to compare their valuations. Based on 2021 guidance, the gas and power segment of Siemens Energy (a business with very little debt) trades at 0.33 times 2021 sales; using this multiple for GE gives an EV of $5.6 billion for GE Power.
Finally, GE Aviation is likely to embark on a multi-year recovery from the low point of the pandemic-hit 2020. Most commentators expect commercial air travel to return to 2019 levels by 2023. If this translates to GE Aviation generating FCF near the 2019 figure of $4.4 billion, it's reasonable to apply a 20-times-FCF multiple to get an EV of $89 billion for GE Aviation.
Is GE undervalued?
Putting all these EV assumptions together leads to a target EV of $184 billion in 2023, and stripping out the midpoint of the net debt guidance of $35 billion to $37 billion leads to a target market cap of $149 billion, or a share price of $17 a share -- coincidentally the target price given by the analysts earlier.
The target price looks reasonable, but GE will have to execute on its margin improvement plan in power and renewable energy to get there. At the same time, aviation has to make a recovery as expected. Fortunately, the latest evidence suggests the company is on track, and based on the figures above and ongoing progress, GE looks undervalued.