General Electric (GE +1.54%) stock is sitting in the middle of a battleground of bulls and bears. The bears point out that the stock is up less than 12% compared to the near 50% gain in the S&P 500 since October 2018, when Larry Culp took over as GE's CEO. Alternatively, the bulls argue that GE has been hit by a unique set of circumstances, including the impact of the pandemic on its aviation-related sales. However, it's now well-positioned to grow earnings and free cash flow in the coming years. Let's take a closer look at the debate.
Image source: Getty Images.
General Electric criticisms
The bear case against the industrial company has three central arguments behind it:
- The company remains largely dependent on fossil fuel-based technology (gas turbines, aircraft engines) and isn't ideal for the clean energy transition.
- GE is a company that remains poorly run despite Culp's efforts, and faces significant end market challenges in aviation (slow recovery in commercial air flights) and power (weak demand for gas turbines over renewable energy).
- Culp's main achievement at GE is to sell off coveted assets, such as the biopharma business and GE Capital's aviation leasing business GECAS, to restructure the balance sheet.
There's not much to get excited about with GE in this bearish context, and the stock's underperformance since Culp took over is warranted. After all, selling off the family silver to pay creditors has rarely been a good idea.
The following table breaks out GE's industrial businesses so you can get a flavor of how GE makes money. Note the pandemic-related slump in GE Aviation's earnings and the impact of the sale of the biopharma business in 2020.
|
GE Industrial Earnings |
2020 |
2019 |
|---|---|---|
|
Aviation |
$0.8 billion |
$6.3 billion |
|
Healthcare |
$2.3 billion |
$3.7 billion |
|
Power |
$0.10 billion |
$1.1 billion |
|
Renewable Energy |
($0.6) billion |
($0.5) billion |
Data source: General Electric presentations.
A different perspective on General Electric
There are usually two sides to a story, and the picture changes significantly if you take a different perspective. So I'll deal with the bullet points outlined above in turn.
There are two points to the "fossil fuel" argument. First, GE also has a fast-growing renewable energy (wind turbines) business. It's loss-making now, but management is busy turning the business around while working through unfavorable legacy contracts in onshore wind. Meanwhile, management expects to grow its offshore wind business from $200 million in 2020 to $3 billion by 2024. Ultimately, the segment is on track to start generating free cash flow (FCF) in 2021 and the longer-term aim is to reach the high-single-digit margins enjoyed by its peers.
Image source: Getty Images.
Second, fossil fuel technology is not dead! Aircraft engines will continue to run on fuel, and gas turbines will remain an economically viable option in many parts of the world. The cost of renewable energy generation is falling, but gas turbines will remain in demand for geographic, political, and environmental reasons.
General Electric's execution
There's certainly a case for GE being badly run in the past, but here's the thing. Value investors often seek such situations. So if management can turn around its execution, there's an earnings growth opportunity as the company plays "catch-up" to its rivals' earnings margins.
Fortunately, that's precisely what Culp is doing with the power and renewable energy segments, and the good news is they are both performing ahead of plan. Power and renewable energy are expected to generate FCF in 2021, and Culp believes the power segment will generate $1 billion to $2 billion in earnings by 2023.
GE Aviation has long been the jewel in the crown of GE. Instead of looking at it as a business challenged by the fallout of the pandemic, investors could consider it a business about to embark on a robust multi-year recovery.
Image source: Getty Images.
Asset sales
The sale of the biopharma business had its critics -- although mainly for the price it went for, rather than the strategic rationale. However, there's little doubt that GE needed to restructure its balance sheet. The sale of the biopharma business, stock in Baker Hughes, and GECAS have given GE the potential to reach investment-grade debt levels in 2023. That will be a major plus for equity and bond investors alike.
Bull or bear?
GE will remain a stock attracting heated debate. However, my view is that the positives outweigh the negatives, and investors should focus more on where the company is headed rather than where it came from.
A combination of recovering end markets and a management team committed to wringing every bit of earnings out of its aircraft engines, gas turbines, healthcare imaging equipment, and wind turbines should lead the company to substantive profit improvement in the coming years. As a result, GE will see better days.
