General Electric (NYSE:GE) remains one of the market’s more divisive stocks. GE bulls see a once-great company destined for a renaissance under new CEO Larry Culp. Bears see an unfocused conglomerate facing real challenges, sitting on top of possibly toxic assets held by the GE Capital unit.
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Indeed, even Wall Street is split. As Barron’s has noted on several occasions, the spread in analyst price targets is over 80% higher than that of the average Dow Jones Industrial Average stock. Bears — with the most well-known Stephen Tusa of J.P. Morgan Chase — see the stock worth as little as $5. The high target price sits at $14.
For now, the market as a whole puts fair value somewhere in the middle. So do I. GE clearly was one of the biggest winners from third-quarter earnings. But risks still loom.
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Earlier this month, GE held an Investor Day for its GE Healthcare business, an effort to give investors and analysts more information on a key business. And that Investor Day seems to be a microcosm of the broader case for, and against, GE. In Healthcare, as with the business as a whole, there is room for optimism, and reason to question whether even that optimism already is priced in.
Where GE Healthcare Fits
GE Healthcare is important to the broader investment case here, but it’s probably not the most important business. Aviation, even with the struggles at key customer Boeing (NYSE:BA), almost certainly is the most valuable. GE Power probably has the most optionality, as it tries to manage a declining market for gas turbines that has showed some life lately.
That said, healthcare matters. In my detailed sum-of-the-parts analysis of GE last year, I estimated the business was worth between $40 billion and $45 billion. Admittedly, some of that valuation is going out the door. GE is selling its Biopharma business, part of the Healthcare unit, to Danaher (NYSE:DHR) for $21.4 billion. That deal, according to a recent regulatory filing, should close in the first quarter.
Still, the remaining business matters to valuation, given that General Electric has a market capitalization just shy of $100 billion. And it matters in terms of much-needed free cash flow, a recent trouble spot for GE.
Healthcare also is important simply as a source of stability. Power’s outlook depends on natural gas power plant demand, which remains uncertain. GE’s investment in Baker Hughes (NYSE:BKR) still is worth almost $10 billion but remains susceptible to oil and gas activity. Aviation should have near-term demand weakness from Boeing and long-term exposure to macroeconomic cycles.
Healthcare is the business that, if all goes right, can provide at least a solid base for General Electric’s turnaround. That makes it more important than a simple SOTP valuation might suggest.
Investor Day Changes Few Minds
That in turn makes this month’s event reasonably important for investors. But, perhaps unsurprisingly, it appears that Investor Day did little to change minds. Neither Tusa nor his fellow bear, Gordon Haskett analyst John Inch, saw anything to change their sentiment. Bulls saw a stable business, with a high amount of recurring service revenue (about 45% of the total, per the company’s presentation).
The unchanged sentiment on both sides can be attributed at least in part to stubbornness. But there’s also a sense in which Healthcare simply is a microcosm of the broader story here. As a bullish analyst noted last week, valuing GE “is not trivial”. Reasonable investors can see equity value very differently, particularly given the still-heavy load of debt and pension obligations.
And those same investors can see the Healthcare business quite differently, even after Investor Day. As with GE as a whole, there’s a good news/bad news split to the business.
GE Healthcare
The good news is that end markets appear stable, and growing. The largest markets, imaging and ultrasound, should increase at a 3-4% annual rate going forward, according to GE. GE Healthcare is the market leader in pharmaceutical diagnostics, including contrast media used in scanning. And digital efforts, plus the Edison artificial intelligence platform, should drive services revenue and help margins.
On the whole, the message from Investor Day is that GE Healthcare simply is a good business. Growth isn’t expected to be torrid, for sure. But it should be steady — and unlike the rest of GE, defensive.
Shares of similar companies like Medtronic (NYSE:MDT) and Stryker (NYSE:SYK) have done well this year, and receive solid, if not quite premium, valuations from the market. GE Healthcare seems similar: a solid business that should drive revenue growth and margin expansion going forward. At the least, Healthcare almost certainly is the safest business in GE’s portfolio, even if that admittedly is a low bar to clear at the moment.
The concern is what’s really left after the sale of GE Biopharma closes in the first quarter. In 2018, GE Healthcare generated $3 billion in free cash flow. The figure excluding Biopharma drops to just $1.9 billion. Segment EBITDA (earnings before interest, taxes, depreciation and amortization) this year, based on guidance, is probably just under $2 billion excluding BioPharma. Applying a similar multiple to GE Healthcare as those applied to MDT and SYK, and the business maybe is worth $30-$35 billion.
That is good news in a sense, as it suggests that, including BioPharma, Healthcare is worth over $50 billion. That’s higher than my estimate, and more in line with a bull case from last year. But it’s fair to wonder, with over $90 billion in debt on the balance sheet, whether that’s quite enough.
A Microcosm
The Investor Day for Healthcare leaves some interesting, and difficult, questions for investors. Is a $30 billion ex-Biopharma really enough to move the needle? It’s helpful, certainly, particularly given that Aviation might be worth more than $100 billion. But, including debt, even those numbers still require that investors see real value in Power and Capital.
There’s also the question as to what GE plans to do with the business. Before the Biopharma sale, the company reportedly was considering a spin-off of Healthcare as a whole. The Danaher deal reportedly has shelved those plans, and management didn’t discuss the possibility of a spin at Investor Day. But Healthcare still is big enough, and valuable enough, probably to stand on its own, but perhaps not big enough for GE to materially change its balance sheet by selling shares. Is that worth giving up a stable, safe, source of much-needed cash flow?
Finally, from an operational standpoint, the question for Healthcare echoes that of the entire company. Are these plans really possible? GE executives projected that the company would increase spending on research and development and grow revenue and expand operating margins by at least a quarter-point annually. “Lean” operations (i.e., cost-cutting) are expected to allow GE to accomplish all of those goals.
But that’s a fine line to walk. The business has to cut costs, but not cut them too far. Competitors in systems too are ratcheting up their investments. Revenue growth may require some concessions on price, and thus margins, particularly with the company highlighting reimbursement pressures from Medicare.
As with GE as a whole, the plans work on paper. In practice, execution will be difficult. And it’s that execution that will determine whether the theoretical bull case results in real returns for General Electric shareholders. Healthcare’s Investor Day highlights perhaps the one thing on which bulls and bears agree: GE still has a long ways to go.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
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