Background – my evolution on GE
Just a brief mention of my published points of view on GE (GE). After this year’s Q1 earnings release, with the stock near $30, I contributed my first article on GE. This was bearish. The bearish thesis was basically that the company was operationally weak, with that weakness being (sort of) covered up by confusing accounting metrics and an emphasis on non-GAAP “earnings.”
I continued to criticize the stock price after Q2 earnings, with the same theme, though with the stock down, just below $26.
These points were almost the same as the ones I began propounding back in July 2013 in my first IBM (IBM) article. With the stock near $190, I titled that article written after weak Q3 results, IBM And The Media Attempt To Obscure Its Declining Business Results. This is how I looked at GE, but not just GE. Also, after Q1 earnings, I wrote a bearish article on another old icon, AT&T (NYSE:T), AT&T: Reasons Not To Touch This Stock. The first summary bullet point of that article basically could have been applied to my prior GE and IBM articles:
- AT&T promoted a “beat” on non-GAAP earnings, but the situation was weak.
This was the basic point I have been making about GE. After the transition to John Flannery as CEO, and now Chairman of the Board, occurred, with the stock in the $22 range and below, I began to get more neutral. The reasons were that, finally, everyone was seeing my bearish points, but I expressed a lot of caution for the longer term, saying I was neutral to bearish on GE beyond a possible short-term bounce (which did not occur).
Now, I see a better set up for alpha following the dividend cut and knee-jerk sell-off. I am beginning to add to my early buy-the-dip starter stake in GE which I instituted before Monday’s Investor Update (average price $20.50 or so), with a multi-year time frame and a minimum price target of $25, more hopefully $30+.
Here is some of my thinking.
GE: big picture comments
All Dow 30 (DIA) stocks receive extra institutional support, simply from being big and important enough to be in the Dow, and specifically from their presence in this index that the public continues to watch. Of them, only GE was an original Dow stock. It goes back to Thomas Edison and continues on with power generation and lighting. Thus, as with IBM and post-break-up heirs to the Standard Oil legacy, GE is in many ways a larger but similar company to what it was in its early days. All this makes it easier for institutions to believe that it can return to some semblance of glory.
Beyond that point, unlike highly leveraged generic drug companies where anything can happen, as they are largely producing undifferentiated commodity products, GE has differentiated assets. The Street can believe that now that it has a limited financial division, which is going to shrink further or be divested, we are looking at a company that cannot pull a 2008 surprise and run the risk of suddenly crashing. So, we can look past the valley and ask, what can the company achieve after necessary actions are taken through, say, 2019. In other words, GE is a stock that bargain hunters such as yours truly can truly take a long term view with, unlike the stock of a plunging commodity company, whether it be a generic drug company or an oil producer or oilfield services company at a time when oil prices are being challenged.
GE: the new tone at the top (Jack Welch redux)
The presentation by John Flannery was not the typical Investor Update one normally gets from a CEO. Normally, even if the company is having some troubles, thanks and general praise for the job done by the prior CEO is in order. After all, one day the incoming CEO will be an ex-CEO. However, the only praise I heard for Jeff Immelt was that he was forward-looking regarding GE’s emphasis on the digital revolution.
What Mr. Flannery said spoke volumes about what he sees as having been done wrongly at GE under Mr. Immelt. Over and over, Flannery talked about analytic rigor. He emphasized operational excellence. Then he came back for the need for quantitative rigor. He almost excoriated (indirectly, of course) the identical issues I have flagged with IBM, T, and GE before, namely unduly complicated financial presentations in the face of obvious P&L issues. He also wants a more efficient board, and advocated for a CEO who did not micro-manage. Instead, he expects each division to improve its operating performance and prove it’s doing so using quantitative, verifiable methods. He pointed to the performance of GE Healthcare under his leadership as exemplary: improved operating margins, which are expected to continue to improve at least through next year. (Interesting, Jeff Immelt’s pre-CEO role was leading that division, I believe.)
Most important to me, he insists on simple financial metrics, such as cash-on-cash returns on capital. He wants to prioritize free cash flow on a divisonal basis as a metric, not the more obscure metrics used by prior management.
That he has been denouncing what happened under Mr. Immelt was made clear in the Q3 conference call.
But what I heard now, and liked, was Jack Welch speaking. I am morally sure the two have been conferring. After Welch was made CEO and Chairman in 1981, he had made many changes in senior management by, I believe, the end of 1982. Mr. Flannery in this presentation pointed to a slide (#20 of the presentation) showing senior executives under him, and mentioned that 40% of them are new since June: very Welchian. These newbies owe their promotions to him, not to the prior CEO, and likely are highly motivated to work extra-hard to keep their jobs. Plus, they are taking fresh looks at the structure of their fiefdoms and are going to be expected to present comprehensive plans on improving ROIC and other metrics. I expect more senior management changes into next year.
Improved focus on secular growth areas
I thought that Mr. Flannery hit the nail on the head when he criticized cyclical Old Economy parts of GE such as oil and gas and locomotives. Yes, he will improve whatever efficiencies he can, but he wants a cleaner balance sheet and secular, lightly cyclical growth. I thought it was a small thing, but worth thinking about, when he mentioned he expects more of a focus on cell therapy in GE Healthcare: is GE getting into CAR-T? This is potentially exciting.
Going through the presentation slides, over and over one sees that GE has strong assets, but that things have not been run with financial rigor (Flannery’s favorite word per his remarks today). There is economic growth all around us again, and for GE, this includes growth in jet engines for both general consumers and military applications. The goal now is to grow GE Additive, which is its 3D printing initiative. It may take a company with GE’s size, business lines and skills to drive this to become a large business opportunity.
Power, writ large, is required for the world to grow economically.
And as people get richer, they want more and better healthcare.
Thus, I like GE’s renewed focus.
Now, the world can only grow at a certain rate. On slide 43, a summing up of what the Flannery era will focus on is seen: “Taking action; operational excellence – back to basics.”
What about 2018?
My first thought is that I don’t really care about 2018. I’m more interested in 2023 and 2028. The key is Welchian focus on operational superiority without the Welchian focus on financialization. With Mr. Immelt, GE shareholders mostly got the worst of both worlds. I am hoping for the best of both when GE does what it needs to do to get back to secular growth basics.
Nonetheless, we should discuss slide 49. This projects adjusted EPS (GAAP may be a complicated story) in the $1.00-1.07 range. It will be a “reset and stabilize year.”
Importantly, slide 50 projects the Power segment to show 10% decline in revenues and 25% drop in operating profits. I am very ready for this to be a “kitchen sink” forecast that may well provide an upside surprise as the year rolls along. I’m not arguing with the revenue projection, because what do I know about that, but somehow I am willing to intuit that if I were Mr. Flannery, I would accentuate the negative right now to have an increased change of playing hero next year.
Meaning, so long as GE stays solvent, which I think is a low-risk bet, next year does not “count.”
Conclusions: GE approaches long term growth stock status (not there yet), or at least deep turnaround status:
In my July 24 GE article, A Bear On GE Outlines Reasons To Avoid This Name, I said that “I have a $15 target price.” This elicited a skeptical comment or two in the Comments thread, but GE has now dropped in less than 4 months to $18.84 as I submit this article, whereas the DIA and S&P 500 (SPY) have risen.
GE now looks a little cheap to the market, and the bad news is out. Whether the entirety of the bad news is out will take time to know, but that’s life in the big city. The prior CEO’s performance has been trashed, and Power may be a kitchen sink story. At the same time, the SPY as a whole is trading at 3X book value; GE is at more like 2.2X. Price:sales is below market, and the slashed dividend yield is a little above 2.5%, which is a little above market, and I believe it is safe for some time to come (barring severe recession, which I do not expect).
My first GE article, in April, was titled GE: Another IBM. That was not meant as a compliment. I will now make a happier comparison for investors who are either holding on grimly or, like me, beginning to scale into GE on the panic. That comparison is to another DIA stock, Pfizer (PFE), the giant Big Pharma company. PFE cut its dividend as the Great Recession was winding down, by the same 50% that GE announced today. The stock had been unusually weak and fell further to the $12-13 range on the news. This was down from a Y2K high in the high $40s (adjusted for any splits). PFE more than doubled from there in the next 4 years, and began increasing the dividend again. Importantly, this was without ever achieving any special operational excellence.
Of course, the markets are totally different between 2009 and today. But the point remains: buying a megacap DIA stock on news that has been foreshadowed, with serious weakness in GE’s operations and financial structure that was so obvious that a retired doctor could see it, can be a wise and brave move. Now, the Fed is tightening, whereas in 2009 it was beginning a record period of continuous easing, so I think that the prices of all financial assets face headwinds unless the Fed eases up (pun intended).
So, I would not be surprised to see things trend right for GE sooner rather than later and have it reach my prior $15 target anyway. But as a general optimist on things, I’m inclined to look some years down the road.
I liked John Flannery’s tone. I liked his diagnosis of what has been ailing GE. I liked his prescription for success. Who can ask for anything more?
Mr. Flannery looks like a mild-mannered Clark Kent, but he talks like a tough leader who demands excellence in every sphere. Whether he can truly be GE’s Superman is to be determined, but my instinct now is to look at GE as a buyer looks at it. This means taking the Warren Buffett and John Templeton view and buying when everyone wants out of the name, so long as the company is facing facts and working its corporate butt off to overcome its problems.
GE’s many strengths may again be coming to the fore.
Thus: long Flannery, long a bit of GE.
In summary: promises have been made. Now it is time to deliver on them.
Thanks for reading and sharing any comments you wish to contribute.
Disclosure: I am/we are long GE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.