The market was buzzing at the beginning of the week when General Electric Company’s (GE) board announced they were firing the CEO they brought in just a little over a year ago, John Flannery, and replacing him with Larry Culp, the 54-year old former CEO of Danaher Corporation (DHR). The news pushed the stock up overnight in a big way, as it opened Monday morning nearly 16% above its closing price on Friday. The stock has retraced a bit from that overnight high, but is still more than 9% above that Friday closing price just a couple of days after the big news broke. If you’ve been an investor in GE over the last few years, this could look like the first good news the stock has seen in a very long time – certainly since December of 2016, when the stock hit a peak around $32 before beginning its extended death spiral to lows not seen since late 2008 when the market was in the midst of the last bear market and the Great Recession.
Is this a good time to start thinking about GE as an attractive value opportunity? Maybe – there are some measurements that make the long-term opportunity look pretty attractive, although my basic value analysis doesn’t put the stock anywhere near the $30 level at any foreseeable point in the future. So calling for a major turnaround in the stock is still an extremely premature and speculative position to take. There are some really critical elements of the company’s fundamental profile that should make anybody with an ounce of sense think twice, and the John Flannery experiment proves that just bringing a shiny new CEO doesn’t guarantee things are going to go the way investors hope quickly.
Moving on from Mr. Flannery in fact is an interesting move, given that he took over a company that many investors perceived had become old and stale, with its fingers in too many pies to be productive. His predecessor, Jeffrey Immelt had made a number of acquisitions that proved unwise, leading to major drawdowns of the company’s cash from large increases of debt to fund those acquisitions; the result was that Flannery was forced to implement drastic measures to make the company leaner and more focused on it core businesses, and even to commit the “cardinal sin” of slashing its dividend. It’s been pretty easy for market experts and pundits, and even GE’s board, to demonize Flannery because his actions didn’t bear immediate fruit, and simply prompted the stock to fall more and more out of favor the more apparent it became that turning around one of the world’s biggest companies was, in fact a herculean task – a task that now falls to Mr. Culp.
The change really begs a couple of questions: Who is Larry Culp? And does the move improve GE’s prospects for a legitimate turnaround? Culp became famous for growing DHR over a 14-year period (2000 to 2014) from a $9.7 industrial manufacturer to about $50 billion. Along the way, he developed a reputation for shrewd acquisitions as he expanded DHR’s operations into healthcare and environmental businesses. The company posted only one year during his tenure as CEO of negative sales growth, in 2009 and also teaches at Harvard Business School. As for the second question, the best way to really answer it is to consider some of the fundamental elements Mr. Culp gets to grapple now as he takes the helm.
Fundamental and Value Profile
General Electric Company is a global digital industrial company. The Company’s products and services range from aircraft engines, power generation, and oil and gas production equipment to medical imaging, financing and industrial products. Its segments include Power, which includes products and services related to energy production; Renewable Energy, which offers renewable power sources; Oil & Gas, including liquefied natural gas and pipelines; Aviation, which includes commercial and military aircraft engines, and integrated digital components, among others; Healthcare, which provides healthcare technologies in medical imaging, digital solutions, patient monitoring and diagnostics, and drug discovery, among others; Transportation, which is a supplier to the railroad, mining, marine, stationary power and drilling industries; Energy Connections & Lighting, which includes Energy Connections and Lighting businesses, and Capital, which is a financial services division. GE’s current market cap is $107 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings dropped more than 32%, while sales increased only slightly at 1.85%. In the last quarter, however, earnings grew almost 19% while sales grew about 5%. GE’s margin profile provides an interesting perspective at one of the problems Flannery was trying to correct, as Net Income over the last twelve months was -$7.1 billion – a number that translates to -5.6% of Revenues. This measurement did improve over the last quarter, but only to about 2.6%. GE is a massive company with diverse business interests, some with larger profit potential than others; but altogether they operate with a razor-thin margin profile that few analysts see improving in the foreseeable future, even if Culp follows Flannery’s lead and continues divesting the company of costly non-core businesses.
- Free Cash Flow: GE’s free cash flow for the trailing twelve month period was around $7.8 billion, and marks a major improvement from the beginning of 2017, which Free Cash Flow was -$2.7 billion. That improvement is attributable in no small measure to Flannery’s divestiture efforts, such as selling the Distributed Power segment to Advent International, and separating GE Healthcare as a standalone company.
- Debt to Equity: GE has a debt/equity ratio of 1.39, which indicates the company carries a high degree of leverage, but does not automatically signal their inability to service their debt. Their balance sheet indicates GE has more than $64 billion cash and liquid assets versus $99 billion in long-term debt, despite efforts over the past year to lower debt by selling off assets. The company should be able to continue servicing its debt, but is still expected to keep working to lower its debt load, even with new management taking charge.
- Dividend: GE pays an annual dividend of $.48 per share, which translates to a yield of 3.8% at the stock’s current price. Considering the fact that the company posted negative earnings in the past year, the conclusion is that the dividend will continue to be a draw on available cash until the earnings trend reverses.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GE is $8.26 per share and translates to a Price/Book ratio of 1.49 at the stock’s current price. Their historical Price/Book average is 1.96, which suggests that the stock is discounted by a little more than 31.4%, and puts the stock’s long-term target price a little above $16 – not bad considering where the stock is at now, but hardly the kind of “screaming bargain” that could lead the market to drive the stock quickly back into the $30 price range investors saw in late 2016.
The truth is while Mr. Culp may prove to be the man to take the company into the future, his task won’t really too much different than Mr.Flannery’s. Flannery appears to be a victim of his own openness about the problems he was dealing with, and with his board’s impatience in executing his plan. Would I take a chance on the potential for a turnaround in GE right now? Not really; bringing Mr. Culp in right now looks an effort by the board to make a splashy move with a market darling that prompts emotional investors to push the stock price a up little bit while it hopes the company’s fortunes can start to turn around sooner than later. After a few months of work, the picture could be quite different, but I think I’ll wait to see what that actually looks like down the road.