2023-11-09 13:30:33 ET
Summary
- General Electric's aerospace business showed strong performance in Q3, with increased revenues and orders.
- The renewable energy segment is still loss-making, but restructuring efforts have significantly cut costs.
- GE's guidance for the year has increased, with expectations of revenue growth and higher free cash flow generation.
In April, I put a buy rating on General Electric (GE) stock as I believe the company's focus on aerospace will provide significant long-term growth for years and decades to come. The company also has the GE Vernova business, which includes Renewables and Power, which despite current headwinds could prove to be a valuable business with investors being able to decide to keep their shares or not once GE Vernova is spun off from General Electric. In this report, I will be analyzing General Electric's quarterly performance, the updated guidance, and provide a stock price target for General Electric, pre-spin-off.
General Electric Flies On The Wings Of Aerospace Business
During the third quarter, General Electric booked adjusted revenues of $16.5 billion, increasing 18% year-over-year, and adjusted earnings of $0.82 per share which was up $0.99. Analysts were expecting revenues of $15.7 billion and EPS of $0.56, so General Electric beat analysts' estimates on the top and bottom line. The company also saw its orders increase by 18% to nearly $18 billion with a $1 billion improvement in free cash flow, bringing the quarterly cash flow to $1.7 billion.
GE Aerospace showed strong order intake during the quarter, growing 34% year-over-year to $9.8 billion. Revenues grew to $8.4 billion driven by 17% growth in equipment sales, which were driven by 12% higher LEAP engine output and an 8% increase in defense equipment sales. Services saw even higher growth at 26%, marking the strength in demand for services as well as its longer-term importance to the business. Profit grew even faster due to positive volume effects and pricing adjustments trickling into the results. I previously pointed out that the 25% growth in revenues would not continue to hold, but I do have to say that there are chances that GE Aerospace will be able to get close. The fourth quarter of 2022 does provide a more challenging comparison, but I do expect that we will see a strong fourth quarter this year.
Important to keep in mind is that increases in LEAP output will be 45-50% higher year-over-year compared to the 50% year-over-year growth guided at the start of the year. This is driven by supply chain challenges dissolving a bit slower than expected as the downward revision was not a function of softening demand.
The renewable energy business shows distinctly different growth rates compared to aerospace. With that in mind, the spin-off might be a positive. Indeed, GE will be less diversified, but it also allows investors to invest in a part of the business without suffering the potential drag from another line of business. Orders grew 3% while revenues grew 13%. The entire Renewable Energy segment is still loss-making, but the positive is that restructuring the business has significantly cut costs. The Renewable Energy segment compounded losses of $1.1 billion and the offshore business is expected to generate $1 billion this year with little improvement from a profit perspective next year. While we don't have a quarterly split of the different lines of business, it does seem that by now Grid and Onshore business' performance is offset by losses in Offshore. The Renewable Energy segment is a bit of a "wait and watch" as at some point further improvement in pricing and mix, including an increased focus on grid services, could start offsetting the Offshore losses, and over the longer term GE expects some sort of reset in the Offshore business, which should provide significantly better pricing.
The Power business saw revenues increase by 9%, but its profit more than doubled driven by volume, price, and higher efficiency. The performance for Power fluctuates from quarter to quarter, but the fourth quarter should be benefiting from seasonality tailwinds on services demand and revenues.
GE Guidance Increases On Turnaround, Pricing, and Demand Strength
The strong performance year-to-date has sparked an increase in guidance for the year. GE Aerospace is now expected to grow revenues by 20% and realize a $6 billion operating profit compared to the $5.3 billion to $5.7 billion expected at the start of the year. GE Vernova will produce high-single-digit revenue growth compared to low to mid-single-digit growth expected earlier this year, while the $100 million to $300 million loss will be a 50% reduction in losses for the year as compared to the guidance at the start of the year driven by Onshore and Grid businesses becoming profitable during the third quarter. Combined, the company expects revenue growth in the low teens and lifted its EPS estimate from $2.10-$2.30 to $2.55-$2.65 and roughly $500 million to $600 million higher free cash flow generation.
Overall, we are seeing better pricing, volume, and efficiency boost results across the business and sparking a significantly better free cash flow performance for the year.
The GE Vernova Spin-Off In 2024 Creates An Aerospace Pure Play
GE turned itself into a rather inefficient conglomerate with exposure to oil and gas, airplane leasing, aerospace, healthcare, and power. GE divested its oil and gas business, while the leasing business in the form of GECAS was sold to AerCap (AER) for which the company received a position of roughly 45%. That has since been reduced to 14.5%, while GE is also reducing its stake in the Healthcare business. The next step in the process, and essentially one of the final steps if not the last one, for GE is to spin off its power and renewable energy business in the form of GE Vernova, now planned for the second quarter of 2024. This will leave GE as a pure aerospace play that could ride the long-term aerospace demand waves.
General Electric: I See Value For The Stock
Valuing General Electric stock is quite challenging for various reasons. One of the reasons is that the enterprise value is a function of its remaining stakes in AerCap and GE HealthCare Technologies (GEHC), and will also depend on how much debt and cash will be spun off to Vernova and the stake that GE will have in that company. We do know that GE Vernova will be spun off in a net cash position, which is a positive for the valuation of the business.
In my assessment, I will be using the current valuation of the AerCap and GE HealthCare stakes as reported by GE, which I believe is conservative. The price target for GE HealthCare is 22% higher than today's value which would put the value of the equity position at around $6.5 billion contrary to the reported fair value of $4.19 billion.
Similarly, for AerCap, an assessment of the stock valuation provides significant upside and would put the value of the position at potentially $2.56 billion compared to the $2.864 billion currently reported and includes a $1 billion note. So, the enterprise value might be about $3 billion too low which provides a headwind to any upside in the stock. In the third quarter, GE reached an agreement to sell Electric Insurance Company, but the transaction value of the business is not known.
Even if we take what I think is a conservative approach toward valuing the combined business, General Electric does have value. The stock is not a screaming buy if you keep 2023 earnings in mind as it is valued ahead of its 2023, and for companies to trade ahead of their earnings is not something abnormal. Perhaps 2024 stock price targets are not even that impressive, presenting a 9% upside. I do feel comfortable putting a 2024 target for $125.34 for the stock, representing a 9% upside, and even a 40% upside toward price targets for 2025.
Another challenge that General Electric's stock price valuation faces is that technically it is a conglomerate. We see some data providers assign it a consumer goods conglomerate, but a CFM LEAP engine is not a consumer good so I wouldn't go with that category as GE being a consumer goods conglomerate is a figment of the past. As a conglomerate, the business does not have a lot of upside. In fact, it does not have any upside. However, what should be kept in mind is that GE will split in an Aerospace & Defense part which typically has a 16x EV/EBITDA targeted, and GE Vernova will be an Industrial Products company which has an industry median of 13.15x. Both of these multiples are higher than the EV/EBITDA multiple of around 12x for General Electric, which in some way also provides support to the spin-off, allowing for better valuation of the companies. Simply applying a 13.15x multiple, which does not appreciate the aerospace business in line with peers, would already put the price target on $134.43 representing a 17% upside which is where I think the stock should at least be trading, as I think EV/EBITDA expansion is justified post-spin off.
The enterprise value of GE might of course fluctuate due to the value of the AerCap stake and the stake in GE HealthCare, but the positive impact on valuation which would drive another 2.6% in upward pressure on the stock has not been taken into account for this. The risk of course is any adverse impact on the stock prices for these companies as well as continued challenges for the GE Vernova end-markets which could affect the valuation of that business and its stock price. Nevertheless, GE has been positioning well for the spin-off and it should also be taken into account that the current valuation could more properly value each business from an EV/EBITDA perspective.
Conclusion: General Electric Has Long-Term Demand Growth Drivers With Increased Separation Value
Looking at the most recent results, I do believe that General Electric is performing extremely well as we saw improvements in results driven by a mix of volume, pricing, and efficiency gains. The Offshore business is a drag on GE Vernova and that will also not go away in 2024, but longer-term positives are that the industry seems to be realizing that things have to change for Offshore, and Onshore and Grid have become profitable. With energy transitions in mind, that is where a lot of potential exists, as well as the aerospace business with long-term demand trends for commercial airplanes and subsequently GE Aviation engines and services.
For further details see:
General Electric: An Aerospace And Renewable Energy Powerhouse With Growth Drivers