Goldman Sachs analyst Joe Ritchie recently described General Electric (GE -0.80%) as a "top idea" and put a $16 price target on the stock. That was good news for investors who own those shares, which closed trading Tuesday at $12.93, but is the bullish outlook justified? Let's take a look at a few of the assumptions Ritchie made and see if they stand up to scrutiny.
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Three points of contention
Some of the keys to the bullish case for the stock, made by the Goldman Sachs analyst and others, are as follows:
- GE's free cash flow (FCF) generation will improve markedly over the next few years and beyond.
- GE is highly leveraged to a reopening of the economy, and global growth is picking up.
- The company could also help itself by managing its businesses better, and CEO Larry Culp is in the process of significantly improving performance.
I believe all of these bullish case points are good ones, and agree that GE as a business will be in much better shape in a few years. Here's why.
Free cash flow
Culp believes GE is on track to deliver a high-single-digit FCF margin by 2023 and revenue in the range of $85 billion to $90 billion. That combination could result in $7 billion in FCF. Based on its recent market cap of $117.5 billion, that would have GE trading at around 16.8 times FCF in 2023 -- an attractive valuation.
Based on his commentary about all four industrial segments, Culp's target looks reasonable. The theory is that aviation will recover in line with commercial flight departures rising to 2019 levels by 2023, taking GE Aviation back to $6 billion in segment profit. In addition, for GE Healthcare, Culp foresees a combination of low-to-mid-single-digit percentage revenue growth and solid margin expansion taking that segment's profit from around $2.7 billion in 2020 to somewhere in the $3 billion to $4 billion range by 2023.
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Meanwhile, Culp's expectation for GE Power to deliver $1 billion to $2 billion in profits looks reasonable because it implies the segment will achieve the high-single-digit percentage profit margin that its peer, Siemens Energy, aims for in its power business in 2023. Culp hasn't put a figure on GE Renewable Energy, only saying that it would be generating earnings in 2023. That's understandable given that the focus of the unit is on growing its offshore wind business from $200 million in revenue in 2020 to $3 billion by 2024 while improving execution in onshore wind and turning around the problematic grid solutions and hydro businesses.
That's all expected to result in a $10 billion total operating profit and $7 billion in FCF. Looking at the longer term, Goldman Sachs believes GE could get to a double-digit FCF margin.
That's a possibility because GE has FCF growth opportunities -- in particular, from growing services revenue in GE Aviation (for engines on the Airbus 320 NEO and the Boeing 737 MAX) and services revenue at GE Renewable Energy (hopefully on all the new wind turbines it will roll out).
Image source: Getty Images.
Self-help and leverage to the economy
The self-help argument for GE's improvement applies particularly to the power and renewable energy segments, which management is restructuring via a multiyear process. The good news is there are already tangible signs of progress. Going back to the outlook meeting in March 2020, GE forecast that the power segment's FCF would be negative in 2020. In fact, it came in slightly positive -- an excellent result under the difficult circumstances of 2020, when site access was hindered by the pandemic.
Similarly, management's forecast for GE Renewable Energy called for FCF to be worse than a $1 billion outflow in 2020 and to remain negative in 2021. The reality was a $600 million outflow in 2020, and management now expects Renewable Energy to generate positive FCF in 2021. In short, the turnarounds for those two segments are running ahead of schedule.
Image source: Getty Images.
As for how the company's fortunes are leveraged to the economic recovery, GE Aviation remains the company's most important business. A rebound in the number of commercial flights will lead to more shop visits for aircraft and engines. In addition, GE Healthcare has a growth opportunity from a rebound in non-elective procedures, and GE Power services revenues should improve as site access does.
Is Goldman Sachs right?
In this case, the bullish argument makes sense. GE looks well-positioned to grow its earnings and FCF in the coming years, and based on the points discussed above, it should be an attractive stock for investors.
