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After Shedding Assets, General Electric Is Worth $20 A Share
Jun.27.18 | About: General Electric (GE)
Contrarian, event-driven, tech, oil & gas
DIY Value Investing
GE shares rallied when the company signalled healthcare and oil services asset sales.
Investor reactions are mixed: cutting debt and shedding these businesses today may hurt long-term growth.
Fair value improves so long as the company grows earnings in the next five years.
This idea was discussed in more depth with members of my private investing community, DIY Value Investing.
At first glance, the market’s ~8 percent rally on shares of General Electric (NYSE:GE) on June 26, 2018, would signal an approval for the healthcare and oil services sale. The company will add $3.25 billion to its balance sheet (before fees) once it sells its Distributed Power business. But questions linger following the news. Although the asset sale will unlock hidden value in the stock, GE will need to find other positive catalysts once the asset sale phase of the company’s turnaround is complete. Still, the debt reduction is a positive step and raises the likelihood that shares bottomed.
GE’s industrial engine unit sale to Advent International for $3.25 billion will not do much to cut the company's debt. It does signal that the sum of the parts are worth more than the current stock price implies. The unit is fetching around 3 times sales, compared to the price-to-book of around 1.98 times. GE’s problem is that it must sell its healthcare and oil services units at similar or higher multiples. As contributor Energy Solutions Partner wrote, the company has $125 billion and $41 in underfunded pension that it must address. After adding $73 billion in "other" liabilities, GE has a book value of just $56 billion.
The Dividend is Safe... For Now
CEO John Flannery’s presentation on the company’s plans to unload its healthcare and energy units will mean the company meets its $20 billion divestiture target and will allow it to keep distributing its dividend. In holding its dividend, the company will avoid income investor stock selling. GE shares already face selling pressure as the company gets removed from the Dow and forces ETFs and index funds to re-balance their weighting in the stock.
Investors cannot help but wonder if the short-term gain from the company’s announcement of an oil services sale will only give the stock a temporary lift. Oil prices staged a rebound recently and are poised to hold that level. The OPEC’s decision to keep output somewhat unchanged will only drive prices higher. Demand is increasing globally for oil. But a trade war between the U.S. and the rest of the world could slow global growth rates and weaken the demand for energy. In that scenario, Baker Hughes’ (NYSE:BHGE) valuation would fall. GE would not be exiting the energy market at the bottom. Since the company is slimming down and thereby simplifying its business, the unit sale is a positive development, regardless of the price of energy.
GE Price data by YCharts
GE revealing that it will sell its healthcare division may surprise its investors. Just last year, the company identified the segment as a core but is now willing to spin-off the unit. If the former conglomerate gives the division its autonomy and retains a majority ownership while spinning out at least 20 percent of the stock float to the public, then the sale will unlocks shareholder value. Once again, GE will divest itself from a market where it is not a leader. Management may turn its focus on its other businesses, namely turbine and aerospace. And with the divestitures, GE will still generate around $80 billion in revenue, annually. Aviation and renewables generated positive CAGR. In fiscal 2017, revenue increased $0.1 billion organically (non-GAAP), driven principally by its Aviation, Renewable Energy, and Healthcare segments. Excluding GE’s Power and Oil & Gas segment, revenue increased a respectable 3%, or $1.7 billion organically (non-GAAP).
Investors have a myriad of methods to crunch the numbers and to arrive at a fair value for GE stock. On finbox.io, estimating the future cash flow of the company and discounting it back to present value in the 5-year DCF EBITDA Exit Model suggests GE’s fair value is around $20 a share. Below, assume revenue falls through to FY2019, stabilizes by 2020, and grows in the single digits for FY 2021-2022:
Source: finbox.io (click the link to enter your own assumptions)
Wall Street does not have a firm conviction for GE stock in either direction: most analysts have a “Hold” rating. Analyst Stephen Tusa from J.P. Morgan, who has a 76 percent success rate and an average return of 14.8 percent over 2 years, called General Electric a Sell.
The analyst has a perfect record on the bearish rating on the stock, averaging a profit of 36.7 percent if followed:
The proverbial time will tell if GE’s asset sale plans stabilize the balance sheet while the remaining divisions support revenue growth in the next five years. For now, income investors need not dump the stock even though the shares are a paper loss. The company plans on continuing dividend payments, signaling that investors will benefit from the flow of cash from operations.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha)".
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