General Electric (GE 1.17%) represents an excellent value despite the near-term risk to its earnings outlook. Furthermore, its value is likely to be released in early January when GE HealthCare is spun off. GE may not be the most attractive company, but it is an attractive stock. Here's why.
NYSE: GE
Key Data Points
The downside risk to GE's earnings outlook
Investing in a stock isn't a beauty contest or just a vote on which company you think has the best chance of beating earnings estimates in the next three months. If it were, the case for buying GE would be weak. But, frankly speaking, there's downside risk to its earnings in the coming quarters.
While management maintained its full-year guidance on the last earnings call, the reality is that its guidance ranges are wide enough to drive a bus through. Revenue is expected to grow between low- to mid-single digits, and earnings per share look to be in the $2.80 to $3.50 range. Moreover, management walked back the free cash flow (FCF) guidance of $5.5 billion to $6.5 billion by telling investors there would be a push out of $1 billion in FCF from 2022.
Moreover, there are signs of weakening momentum in its business. For example, supply chain pressures are crimping earnings at GE HealthCare. As a result, management now expects the segment's profit to be around $3 billion (compared to a previous estimate of $3.1 billion to $3.3 billion). In addition, GE Renewable Energy, along with its peers Siemens Gamesa and Vestas, has lowered profit expectations in 2022 due to ongoing supply chain and cost pressures and political uncertainty regarding the outlook for the U.S. onshore wind market. On the other hand, GE Aviation and GE Power are performing broadly in line with expectations.
However, it's possible that rising interest rates and a slowing economy will reduce the profitability of commercial airlines and, in turn, reduce flight departures and aircraft orders. In that case, GE Aviation could see slower growth.
Valuations still matter for General Electric
As noted earlier, GE has a risk to its earnings outlook in 2022. On the other hand, the stock price seems to have fully reflected that risk, and GE now looks like an excellent value. One way to judge this is by looking at the forthcoming spin-off of GE HealthCare -- which is the first part of its breakup plan (that also includes combining GE Power and GE Renewable Energy and spinning it off as GE Vernova in early 2024).
GE HealthCare's principal competitor in its core imaging and ultrasound markets is Siemens Healthineers. The latter trades on an enterprise value (market cap plus net debt)-to-earnings before interest and taxation (EV/EBIT) multiple of 18.4. Assuming GE HealthCare deserves a similar EV/EBIT multiple in 2023, the $3 billion in segment earnings expected for GE HealthCare in 2022 gives GE HealthCare a potential EV of around $53 billion.
Note that this is a very conservative estimate which assumes no growth in GE HealthCare's earnings in 2023. Based on management's previous aims for GE HealthCare, I think there's potential for up to $3.7 billion in EBIT in 2023, pushing the EV up to $65 billion. However, for argument's sake, let's be conservative and stick with $52 billion.
What about the rest of General Electric?
At this point, it's worth noting that GE's total EV is only around $93.5 billion, meaning that GE Aviation and GE Vernova together would be valued at $42 billion. The breakup costs ($2 billion in separation and $0.5 billion in taxes) mean it's better to assume $44.5 billion. Still, that seems a very low valuation for GE Aviation alone.
Meanwhile, GE management believes GE Aviation will generate $3.8 billion to $4.3 billion in profit in 2022 and $6 billion in 2023. While there's no guarantee GE Renewable Energy won't be loss-making in 2023, GE Power is set for $1 billion to $2 billion in profit. Moreover, Siemens Gamesa is a loss-making wind-power business that traded on an EV of at least $10 billion at its lowest point this year.
A stock to buy
No one likes buying a stock with risk to its earnings outlook ahead, but the sell-off in GE stock has probably gone too far. As such, the stock looks like a compelling value for investors willing to ignore the potential for some negative news flow in the coming months.
