When General Electric Co. CEO John Flannery said investors who bet against the company’s stock would do so “at their own peril,” he wasn’t being unreasonable. If you short-sell a stock, your potential for losses is unlimited.
So the question is, should you buy shares of GE now?
The answer is “yes,” according to William Blair analyst Nicholas Heymann, whose been covering General Electric GE, +0.71% as an analyst continuously since 1983 and even worked for the conglomerate as a financial analyst and auditor from 1978 to 1981.
Heymann expects the stock to rise over 50% this year after it crashed 52% in the past 12 months.
Also see: Why you should never short-sell stocks
Among the 20 sell-side analysts covering GE polled by FactSet, five recommend buying the shares, three recommend selling and the remaining 12 have neutral ratings. So the analysts, as a group, don’t expect much more of a decline. That’s after GE cut its dividend by 50% and lowered its 2018 earnings forecast by about half.
Heymann is among analysts who say GE’s shares have fallen too far. He rates the stock “outperform.” GE’s shares closed at $14.50 on Tuesday and traded for 15 times the consensus 2018 earnings-per-share estimate of 97 cents.
“If you are at a buck earnings trough, you should get 20 times that,” Heymann said in an interview Feb. 27. He expects the shares to rise to $22 by the end of this year.
Heymann admits he “never got off the bus” — he had a positive rating for General Electric in the fall of 2015 before everything came crashing down. It’s one of the biggest disasters in U.S. business history, as long-serving CEO Jeffrey Immelt left under a cloud before Flannery was promoted to the top job.
Heymann outlined his case that GE’s stock is a good value, with comments in these areas:
- Cash flow
- Baker Hughes
- Aviation and health care
- Health-reinsurance obligations
- Pension obligations
- Monetizing the transportation unit
- New board members
Read on for the details.
Improving cash flow
Even though Flannery was a 30-year GE veteran when named CEO last year, Heymann believes he is the right man to clean up the mess. Flannery made quick efforts “to peel out all units that didn’t earn their cost of capital in the health division,” when he was named CEO of that unit in 2014, Heyman said. “This is our template for what he might do for all of GE.”
Despite some frightening headlines in the financial media, Heymann expects no further dividend cut or issuance of shares to raise money. He expects GE’s planned sale or exit from underperforming businesses valued at $20 billion to net the company between $12 billion and $15 billion in cash by the end of 2019.
Here are six areas where Heymann expects GE’s remedial efforts to pay off for investors:
GE formed the awkwardly named Baker Hughes, a GE Co. BHGE, +1.18% when it merged its oil and gas equipment and services business with the old Baker Hughes in June. GE owns 62.5% of the joint venture, and it can consider strategic options for that stake beginning in July 2019. Heymann believes GE will not sell its stake because of the partial recovery of oil prices. Higher prices bode well for offshore production, which accounts for 25% of the combined unit’s business. Heymann also expects GE’s major investment in its predictive analytics service to improve the unit’s earnings “from a very low base.”
Aviation and health care
“Regulators would not like this, and it would also kill their business of selling engines to Airbus EADSY, -0.53% ” he said.
Heyman added that GE’s aviation and health care segments were expected to provide two-thirds of the combined company’s earnings and free cash flow in 2018, and that both units had exceeded analysts’ earnings expectations in the fourth quarter.
Health reinsurance obligations
GE took a painful $6.2 billion after-tax charge on its legacy long-term health reinsurance business, for which the company stopped writing premiums in 2006. According to Heymann, under the new tax law, that charge rises to $7.5 billion. The company also estimates it will spend $15 billion over the next seven years to shore up its insurance reserves. The company recently arranged a new $13 billion credit line with a group of banks, after it announced the charge and planned spending, indicating confidence that GE will get it right this time.
GE’s pension obligations are underfunded by an estimated $31 billion, including $19 billion in mandatory obligations and $12 billion that are voluntary. That $19 billion is going to be reduced by a $6 billion contribution as the parent company assumes $6 billion of GE Capital’s debt and $6 billion of that unit’s cash. Heymann expects a major benefit to GE from rising interest rates. Every quarter-point increase in the yield of 10-year U.S. Treasury notes TMUBMUSD10Y, +0.00% “reduces the pension deficit by $2.2 billion,” because the discount rate used to calculate the obligations rises, he said.
A likely transportation unit sale
GE’s plan to sell or exit $20 billion in underperforming businesses does not include its Transportation division. Flannery has said the company is considering its options for the unit. Heymann believes it will be merged with Bombardier’s BDRBF, -1.11% transportation unit, but not until Airbus closes its purchase of a majority stake in a new partnership to make Bombardier’s C Series aircraft.
New board members
On Monday, General Electric said it would reduce the size of its board of directors to 12 members from 17 and named three new director candidates. H. Lawrence Culp is a former CEO of Danaher Corp. DHR, +0.24% ; Thomas Horton is a former CEO of American Airlines AAL, -0.56% ; and Leslie Seidman is a former chairwoman of the Financial Accounting Standards Board (FASB).
Among the things GE said its governance committee was looking for was board candidates who would have “the ability to devote a significant amount of time to the company versus other obligations.”
Heymann is impressed with all three candidates, citing Seidman’s accounting expertise, calling Culp “a good operating industrial executive,” and saying Horton’s expertise would be of great value to the Aviation unit.
Heymann expects more turmoil as GE continues to work through its problems and simplifies itself into a company with three major markets: power, aviation and health care. But he also believes Flannery’s moves to “reset everything” and simplify the business will enable the company to lift its annual cash flow to “the mid teens” (in billions of dollars) by 2020 and even consider raising the dividend that year.