The stock of General Electric (GE +1.96%) has surged 85% over the past year, a testament to the growing investor confidence in the company's imminent restructuring. As GE Vernova (the power, renewable energy, and electrification business) prepares to debut on the market on April 2, the remaining entity, GE Aerospace, holds significant potential.
Despite the stock's impressive performance, is it still a value proposition? Let's delve into the details.
General Electric's breakup
As I've previously highlighted in a comprehensive analysis, GE Vernova's market cap is conservatively estimated at around $27.3 billion. However, the current value of GE stock is around $183 billion. Notwithstanding the fact that the $27.3 billion estimate for GE Vernova is conservative (meaning it's a good investment at that level), is the implied $155.7 billion a reasonable valuation for GE Aerospace?
NYSE: GE
Key Data Points
Why General Electric's stock has soared
There's little doubt that the market has revalued the GE Aerospace portion of the company over the last year, and I think there are a few reasons for this:
- GE Aerospace has operationally outperformed other large-cap commercial aerospace giants like RTX and Boeing.
- The company is also less exposed to some of the margin and supply chain issues in the defense industry that have affected and continue to affect RTX, Lockheed Martin, and, to an extent, Boeing.
- Investors stopped pricing GE as an industrial conglomerate and started thinking about the company as "GE Aerospace+GE Vernova" and valued it accordingly (aerospace companies tend to trade at valuation premiums to industrial companies).
GE Aerospace's rival engine maker RTX (the two offer competing engines on the Airbus A320 neo family) had a disappointing 2023 after discovering a potential contamination of powder coating used in turbine discs on its engines, which requires engines to be removed inspected, resulting in a multibillion-dollar hit to earnings and cash flow.
In addition, RTX's defense business continues to be pressured by delivering on fixed-price development programs signed in less inflationary times (Boeing and Lockheed Martin also have this issue).
Meanwhile, Boeing's commercial aerospace business has no shortage of problems, and there are question marks around the timing of its production ramp up and, more importantly, the kind of profit margin it will achieve. In contrast, GE Aerospace's lack of issues has made it the favored stock in the large-cap aerospace sector.
Image source: Getty Images.
GE Aerospace valuation
As noted above, aerospace companies trade at a valuation premium to industrial companies to reflect the long-term earnings and cash-flow streams from their services revenue. For example, the aircraft engine model (GE and RTX both follow this) is to sell engines at a loss only to generate decades of higher-margin parts and service revenue.
As such, when equipment deliveries are ramping up (as they are now with the LEAP engine on the Airbus A320 neo family and the Boeing 737 MAX, the GEnx engine on the Boeing 787, and in the future the GE9X on the Boeing 777X), profitability is depressed in relation to what it will be when the engines are in use for a few years and the revenue mix shifts to higher-margin parts and services.
As such, nobody is pricing GE Aerospace for what it is now, but rather what its future earnings and cash flow will be. For example, my estimate for the implied value of GE Aerospace of $155.7 billion means GE Aerospace is valued at 31.1 times management's estimate for free cash flow (FCF) in 2024, as shown below.
|
GE Aerospace |
2023 |
2024 |
2025 |
|---|---|---|---|
|
Adjusted revenue |
$32 billion |
Low double-digit growth |
Low double-digit growth |
|
Operating profit |
$5.6 billion |
$6 billion to $6.5 billion |
$7.1 billion to $7.5 billion |
|
Free cash flow |
$4.7 billion |
$5 billion |
Greater than 100% conversion from net income |
Data source: GE Aerospace presentations.
It's an extremely high figure for an industrial conglomerate but comparable to the valuations accorded to other aerospace-focused companies (see chart below). In addition, note that GE Aerospace will see some margin pressure in the coming years as engine deliveries ramp up and their share of the revenue mix grows. In other words, GE's earnings and cash flow in the near term don't reflect its long-term potential.
HEI price to free cash flow; data by YCharts.
Is General Electric still a good value?
Based on the numbers above, GE is starting to look close to being fully valued. One Wall Street analyst thinks there's still high-single-digit upside potential to the stock price, which looks reasonable, albeit unexciting.
That said, GE's valuation has possibly been bolstered by the perception that it is a "go to" stock in the aerospace and defense sector in light of the Boeing, RTX, and Lockheed Martin issues. That could change if the three start improving operationally.
The best way to consider the investment opportunity is to look at what GE Vernova and GE Aerospace are valued at after the spin. Anything less than $27.3 billion for GE Vernova is an excellent value opportunity, while less than $155.7 billion for GE Aerospace provides a little upside.
