General Electric (GE 0.94%) CEO Larry Culp gave some investor presentations recently and what he said helped investors think about the investment opportunity over the long term. It's no secret that GE needs to improve its earnings and free cash flow (FCF), and the good news is it appears to be on track. Indeed, Culp has referenced a figure of $7 billion as an initial target. The question is whether that figure makes the stock a good value or not. Moreover, what about GE's growth prospects once the turnaround is nearing completion?
Culp believes GE is on track to generate around $7 billion in FCF by 2023 due to a combination of revenue of $85 billion to $90 billion with a high-single-digit FCF margin. What's more, GE's implied guidance is better than what Wall Street analysts have penciled in, so there's room for optimism.
Culp discussed the matter during the recent Bernstein Annual Strategic Decisions Conference. In a nutshell, he's expecting around $10 billion in operating profit (in 2023) to convert into around $7 billion in FCF. These are only ballpark figures, so don't take them as written in stone, but Culp talked about $6 billion in operating profit from aviation, with $3 billion to $4 billion from healthcare, $1 billion to $2 billion from power, with renewable energy operating profit "positive." The midpoints of the ranges add up to around $10 billion in operating profit in 2023 for the industrial company.
Armed with the figure of $7 billion, investors can take the current market cap of $118.8 billion and pencil in a valuation of 17 times FCF in 2023. Given that many investors see a valuation of 20 times FCF to be a fair value for a mature industrial conglomerate, GE looks undervalued.
Looking beyond 2023 and the $7 billion, the key question is whether GE really is just another mature industrial conglomerate with low-single-digit earnings growth prospects.
Fortunately, there's good reason to believe that GE does have good long-term growth prospects. Starting with GE Aviation, the key thing to focus on here is long-term aftermarket and services revenue. Essentially, GE Aviation sells aircraft engines at a low or negative margin (at least initially before production ramps up and cost per unit of production falls) in order to generate higher-margin aftermarket and services revenue. Typically, an engine will have its first "shop visit" in its first five to seven years, and then a second after 10 years, and then another two visits around year 15 and year 20.
That's a key point to consider because GE and its joint venture with Safran, CFM International, have an installed base of 38,000 engines in the world, and more than 60% of it has only had one shop visit. In other words, there's plenty of long-term growth potential in the existing engine fleet, and with engines on the Boeing 737 MAX, Airbus A320neo, Boeing 787, and Boeing 777X, the future looks bright for GE Aviation.
Of course, the pandemic has pushed back shop visits due to a lack of flight hours and engine retirements. However, GE is expecting engine shop visits to be back to 2019 levels in 2023, and from then on, it's reasonable to expect good growth in services revenue.
Power, healthcare, and renewables
GE Power is likely to be a "self-help" story in the next few years. The gas power (around three-quarters of revenue in 2020) is already FCF positive, and management is on track to improve margin in line with its peers. It's a somewhat similar story in the power portfolio (steam power, power conversion, and nuclear), albeit with a delay in the recovery due to GE exiting the new coal build business.
Culp's discussion of $1 billion to $2 billion in FCF is a positive. Still, given the strength of the "energy transition" toward renewable energy, it's hard to think of GE Power growing more than at a low-single-digit rate once its margin aligns with its peers.
GE Healthcare is interesting in the sense that the market is rewarding healthcare businesses with high valuation multiples. It's a point recognized by Culp when he remarked, "We know this business is more valuable to investors, and we can get that low-single-digit growth rate up sustainably into the mid-single-digit range." It wouldn't be surprising to see the company focusing its acquisition and investment activity in the segment.
Turning to renewable energy, grid solutions and hydro are forecast to be a breakeven business in the 2022-2023 timeframe. In addition, offshore wind is expected to grow from $200 million in 2020 to $3 billion by 2024. Meanwhile, management is focused on working through lower-margin legacy contracts in onshore wind and raising the margin profile on new contracts. Thinking longer-term, GE has an opportunity to increase higher-margin services revenue (currently just 20% of segment revenue) as the installed base of wind turbines grows.
Is GE a good value?
The growth prospects discussed above, most notably in the aviation (aircraft engine servicing) and renewable energy (growing services revenue) segments, suggest that GE does have the potential to be more than a low-single-digit earnings grower in the post-2023 environment. GE's healthcare and power business will provide solid support. As such, a price-to-FCF multiple of 17 times FCF (assuming GE hits $7 billion in FCF in 2023) would make the stock a good value.