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What to Expect From General Electric as Its Turnaround Accelerates

Just when investors thought General Electric (NYSE:) would never rebound, the company’s solid fourth-quarter results changed everything. GE stock added over $1 to its share price after beating on earnings and revenue expectations.

GE’s strong results are due to its strong management team. The recovery in its business is only a start. And while the stock 10 buy and 4 hold ratings, the lone “sell” call ought to change by now.

General Electric posted , but that figure was up 1% in 2019. Renewables, healthcare and aviation offset weakness in its power division. Still, power beat GE’s full-year expectations, thanks to the gas power unit stabilizing. The company’s backlog grew 15% year-over-year to $405 billion. Now, its services business makes up almost 80% of that total.

Investors should applaud GE’s improved financial position, as it cut its debt by $7 billion. Its non-GAAP net debt-to-EBITDA (earnings before interest, tax, depreciation and amortization) ratio of 4.2 times is a drop from 2018’s 4.8 times. Of course, its Wabtec (NYSE:) and Baker Hughes (NYSE:) transactions brought in $9 billion in proceeds. The sale of its biopharma unit will give GE $21 billion. So, the overall asset reduction of $27 billion in 2018-19 will exceed its previous $25 billion asset sale objective.

Improving Balance Sheet

GE generated free cash flow of $3.9 billion in the quarter. This is despite the Boeing 737 Max grounding adding to a $1.4 billion cash headwind. Looking ahead, innovations to its digital capabilities will only strengthen its health division.

In renewables, GE’s earnings and cash flows improved throughout last year. But the offshore wind division still requires investments. In the long term, this business will have a global presence. The launch is a turning point for the business. It represents “the world’s most powerful offshore wind turbine.”

At the end of 2020, GE expects its leverage ratio will fall below 4 times.

Business Strength

GE’s healthcare unit is a clear growth catalyst. Selling the biopharma division will free the company to turn its focus on growing its healthcare systems unit. The company grew this segment’s revenue by 1% organically. In future periods, growth will pick up in the low to mid-single digits. Near term, higher research and development expenses will delay the profit growth but long term, profit growth will accelerate.

Boeing’s 737 Max grounding is a big unknown for now. GE management is planning for the delays by adjusting its cost structure, but is also ultimately planning for its eventual return. For now, it is planning for a rapid ramping up in deliveries later this year. A mid-year return to services is a more optimistic scenario. The markets are not pricing in the cash it brings if indeed engine delivery resumes sooner.

Turnaround in Power Unit

Just as GE’s aviation unit performed well without Boeing’s business, its power portfolio did not do so poorly. CEO Larry Culp said that within this portfolio:

“We’ve got Power Conversion is but one, and call that roughly $1 billion P&L, where they have really grabbed the organization firmly and are driving costs out improvements, better quality, better delivery performance, smarter underwriting.”

If GE’s worst division turns around, then it looks as though the worst is behind it.

Valuation

GE stock has the lowest quality score compared to its peers:

At around $12.50, the stock’s margin of safety is below 10%. In a 5-year discounted cash flow growth exit model, investors may assume that revenue stops declining. This model uses a revenue exit multiple to calculate terminal value after five years. Assuming a discount rate of 8.5%, the stock’s fair value is almost $14.

Metrics Range Conclusion

Source: (click on the link to change assumptions)

As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.

The post appeared first on InvestorPlace.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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