Disastrous Results as Expected for GE

Joshua Aguilar: As expected, GE reported disastrous third-quarter results today. Even so, we anticipated the firm would disclose a kitchen sink of bad news. The stock is flirting with 5-star territory as the price of the stock has dropped below $10. If the stock drops down to our 5-star price, at just above the midpoint between $9 and $10 per share, we would be buyers of the stock. At that price, investors would be paying for what we believe are GE's wide-moat businesses in aviation and healthcare, which cumulatively have an enterprise value of about $160 billion, could attach all of GE's foreseeable liabilities, and get the remaining portions of the business for free. Note, these businesses alone are worth more than GE's current enterprise value, and GE has the benefit of having separate market values for both oil and gas, as well as transportation. Bottom line, we’re hoping Mr. Market beats down this stock to our 5-star price so investors can enter the stock at what we believe is an attractive price point.

The firm did cut its quarterly dividend, as expected, to a penny per share from 12 cents per share previously. While the cut is unfortunate, this was also something we anticipated and built into our model. Year to date, the company has paid out $3.3 billion in dividends but has only generated industrial free cash flow of negative $335 million. If anything, what we did not expect was that GE would preserve any remaining portion of its dividend, as we would have preferred the dividend being cut in its entirety. Danaher, which Culp ran from 2000 to 2014 only paid about a 3% to 4% dividend payout ratio, and we think Culp will use the cash to delever the balance sheet, as well as reinvest in the remaining businesses.

We also believe Culp will broadly stick to the aviation, power, and renewables plan. That being said, however, we expect important changes in execution, including as to certain business lines Culp might have GE exit. For example, GE announced it would split GE power into two units, with natural gas in one portion, and steam, nuclear, and grid in another. Culp claims after a review that power is too big to be run efficiently. We agree with this assessment and found that GE runs at about a 55% rate of efficiency compared to Siemens Power & Gas, when measured by segment profit per employee. That said, we would not be surprised if Culp looks to shed the future steam unit given the unattractive economics of coal over the long run. Assuming current margins, we expect that the net present value of selling this business is about 40% greater than for GE to retain it.

While it will take Culp and his team several years to turn around GE, we are confident in his ability to close the stock's gap between the market price and our assessed value.