Now that the dust has settled on the news of General Electric's (NYSE:GE) break-up plans, it's time to take a closer look at the new companies to come. There's no doubt that the GE Healthcare spinoff and the portion of the company that won't get spun off will be the stronger two, but I think the third business will be the most interesting. Here's why investors should not be quick to dismiss the combination of GE Power, GE Renewable Energy, and GE Digital.
The third man
As a reminder, GE's plans involve spinning off GE Healthcare in early 2023 (with GE retaining a 19.9% stake in the new company), and then combining GE Power, GE Renewable Energy, and GE Digital into one business and spinning that off in 2024. What's left will be an aviation-focused company.
One thing that's unclear at this point is how much debt each of the three companies will take with them under the plan. What is known is that management plans for each of them to have balance sheets that qualify their debt as investment-grade when the separations are complete. Management should have the financial flexibility (not least through its equity in Baker Hughes and AerCap, and the 19.9% stake GE will hold in GE Healthcare after the spinoff) to ensure that.
On the face of it, the new energy-focused business is the weakest of the three. But CEO Larry Culp has been vocal about his expectations for each segment's profitability in 2023. According to Culp, GE Aviation is likely to reach $6 billion in segment profit in 2023, with GE Healthcare's profits in the $3 billion to $4 billion range.
Turning to "GE Energy," GE Power is expected to produce profits of $1 billion to $2 billion. Still, the lack of specific commentary (in terms of forecast 2023 earnings) on GE Renewable Energy suggests limited incomes, and GE Digital is a business that's only likely to break even in 2021.
Between the lines
On closer inspection, there's a lot more to like about GE's energy business than meets the eye.
First, it appears that the market is currently being overly negative about fossil fuel technology. (GE Power's leading profit sources are gas turbine equipment and services.) You can get a sense of this by looking at Siemens Energy, which was created by combining a 67% stake in Siemens Gamesa Renewable Energy and Siemens' former gas and power business.
Given that Siemens Energy has a market cap of 17.4 billion euros (about $19.5 billion) and Siemens Gamesa has a market cap of 14.6 billion euros (about $16.4 billion), it appears that the market values the gas and power business of Siemens Energy at just 7.6 billion euros.
At the midpoint of management's guidance range, Siemens Energy is looking for the gas and power business (a direct competitor of GE Power) to generate 1.04 billion euros in earnings in 2022.
In other words, the market is valuing the gas and power business of Siemens Energy at just 7 times its forward pre-tax earnings. While a lot can happen between now and 2024 (when GE will spin off its energy business), it appears that the market is severely undervaluing companies with gas turbine businesses. The world may well be making a transition to clean energy, but natural-gas-powered electricity generation will still be here for a long time to come.
GE Renewable Energy and GE Digital
Second, GE Renewable Energy may well not report a significant profit in 2024, but that doesn't mean the four businesses that comprise it don't have a lot of potential. For example, onshore wind (which accounted for $10.9 billion of the segment's $15.7 billion revenue in 2020) is already profitable. Still, the near-term outlook is unclear due to the uncertainty around how its clientele will react to the likely extension of production tax credits (PTC) for wind energy. A PTC extension would be good news over the long term, but it could distort the timing of orders in the next few years. Nevertheless, onshore wind energy is a growth business.
Offshore wind ($200 million in 2020 revenue) is a developing business for GE. Still, management believes it will break even in 2022 and generate cash flow as GE builds it into a $3 billion revenue business by 2024. Meanwhile, it's restructuring its grid solutions and hydro businesses with the aim of the former hitting breakeven in 2022 and the latter in 2023.
Finally, GE Digital (the company's Internet of Things segment) is a natural fit for the energy business. Its primary focus is improving asset utilization in the power grid and improving services offerings for GE Power and GE Renewable Energy. For example, with IoT tech, utilities can better predict when their gas and wind turbines will need servicing. GE Digital shouldn't be underestimated. It's a business with more than $1 billion in revenue and should break even on the bottom line in 2021.
GE's energy business has potential
All told, all four of GE Renewable Energy's businesses should be profitable and on an uptrend by the time they are spun off in 2024. In addition, GE Digital will provide valuable and integral help to the other units to improve their profitability. Finally, the spinoff will be able to use the earnings and cash flow from GE Power to support investments in growing the renewable energy businesses.
Moreover, if the market continues to undervalue power businesses, investors will have an opportunity to buy into a collection of growth assets at a very reasonable price. If the GE spinoffs were happening right now, its energy assets would be the first businesses investors would want to look at.