EUR 850.00 For Business Accounts Only

Morningstar | We Believe the Fundamental Bottom for GE Stock Is Fast Approaching; Slightly Reducing Our FVE

After digesting the March 14 investor presentation disclosures and making a thorough review of narrow-moat GE’s 10-K filing, we anticipate reducing our fair value estimate by about 10% to around $12.40 from $13.80 previously. About 2% of the 10% reduction is due to the Wabtec spin where we included this portion as an enterprise value adjustment, while the remainder is due to our view of a prolonged recovery. We believe GE Power will take significantly more time than we initially anticipated to turn around, and we think GE Renewable Energy faces considerable headwinds as it makes its way through the production tax credit cycle. Moreover, we have a more conservative view of GE Aviation’s midcycle margin as the LEAP-CFM engine shift takes place heading into 2019 as well as the effects from the introduction of the GE9X engine.

Even so, we were pleasantly surprised to find strength in military engines and services, as well as margin strength in GE Healthcare, even after the disposition effects from GE Biopharma. Overall, we are pleased with Larry Culp’s leadership and the firm’s inroads toward greater transparency. Our valuation credits GE with a recovery in the Power and Renewables segments; Larry Culp is key to this view.

Shares have now rallied nearly 50% since we recommended the stock on Christmas Eve. One item that still concerns us, candidly, is the firm’s GAAP actuarial assumptions behind its insurance reserves, particularly as it concerns the discount rate. After a review, the firm recently opted to raise the discount rate from about 5.7% to just over 6% given an assumption of greater returns from different asset classes. Even so, GAAP accounting rules will obligate GE to change this assumption in 2021, in line with an upper-medium grade fixed income instrument. While it’s impossible to prognosticate the actual rate, we assume 4% beginning in 2021. While this will not impact GE’s statutory reserves, which are overseen by the Kansas Insurance Department, we still foresee an impact to the firm’s earnings. Our valuation of GE Capital remains in negative territory (about negative 76 cents per GE share).

That said, Larry Culp deserves credit for taking decisive action, including obtaining a favorable price with the Biopharma sale. One thing we appreciate about Culp is his willingness to deviate from the script should circumstances necessitate such action. Specifically, the firm has now decided to retain GE Healthcare given its cash generation and the cash burn that would result without the unit. We think this is the right decision. Our sum of the parts valuation now stands at about $13.00, but we now believe sum of the parts bears less importance given that the firm will mostly focus on its remaining businesses (with the exception of BHGE). We caution investors that the short-term catalysts in the stock have now materialized, and a realization of value from here on forward will likely take years.