General electric is uninvestable – general electric company (nyse ge) seeking alpha gas company


It doesn’t take much for bottom fishers to get excited about General Electric ( GE). An underperforming cyclical business and rock bottom share prices are definitely an alluring combination for those looking to capitalize on the stock’s “cheapness.”

A while back I stated that General Electric’s stock could get interesting at $18 . This was when the stock traded at $30. Since then, shares have declined well past the $18 level to as low as $13 before coming back recently on the back of the restructuring story getting more traction. Despite this general optimism towards the company’s ongoing restructuring efforts, I believe that the company is now uninvestable. Restructuring Hoopla

General Electric is definitely making a lot of noise. The company is aiming for $20 billion of asset sales, and the management is considering “ all options .” A part of the management’s grand plan was unveiled this week with the announcement of a merger between the company’s transportation unit and Wabtec ( WAB). Based on the stock’s positive movement on Monday, it is clear that investors are buying the narrative that the management is righting the ship.

Amidst this noise, it would appear that investors have completely forgotten about the company’s deteriorating financials. Let’s not forget that the company has been in perpetual restructuring mode over the past several years. Yes, Immelt is out and Flannery is in, but I have yet to see any changes that would unlock shareholder value. The market is forward looking, so clearly investors are expecting that the Flannery-led restructuring efforts will yield good results, but I believe that such an optimistic outlook is unwarranted.

A core pillar of the company’s restructuring strategy is divestitures and spin-offs. It is generally accepted that spin-offs can create shareholder value. However, let’s not also forget that mergers are supposed to create value too! Every situation is different, and I think it is silly to think that spin-offs and divestiture will automatically generate wealth for shareholders. In fact, some analysts have pegged the break-up value at just $11-$16/share, which isn’t so far from the current price of $15.26.

The reason for my pessimism is due to the fact that GE isn’t suffering from a valuation discount right now, a problem that spinoffs could cure should the spun-off entities get repriced. The company trades at a 16x current year earnings multiple despite a negative earnings trend, with adjusted Industrial plus Verticals EPS (i.e. excluding the prior insurance adjustment, tax reform, and other restructuring charges) down 30% year over year in 2017 from $1.49 to $1.05. Let’s not forget that the insurance adjustment IS a real loss because ultimately those losses will be paid in cash.

To see how General Electric spinoffs will fail to generate substantial value we need to look no further than the newly announced Wabtec merger. General Electric will receive $2.9 billion in cash but will contribute GE transportation at a valuation of just $10 billion (including the $2.9 billion of cash receipt).

GE Transportation generated $824 million of segment profit in 2017, down from $1.064 billion in 2016. If we average of the two years, the transaction EV/EBIT multiple is roughly 10.6x. However, the management is quite optimistic about a rebound in the business, stating that the segment’s revenue and adjusted EBIT will grow at a double-digit CAGR through 2019. So really, the forward multiple is likely below 10x. At Wabtec’s 23% tax rate, my estimated EPS multiple for this transaction is somewhere around 13x. However, since GE is not handing over any debt, Wabtec has the opportunity to apply additional leverage to make the valuation even cheaper. All of this compares poorly to the aforementioned 16x current year earnings multiple, which implies that this deal will likely be dilutive .

Why would General Electric shed GE transportation at such a depressed valuation despite a supposedly bright future? I believe that either the business is expected to do poorly contrary to the current projection by the management or that the management is incapable of making intelligent decisions. Neither of these bode well for General Electric over the long-term. Analyst Praise

Readers can find some analyst comments here on Seeking Alpha . I came away unimpressed. Many praised this transaction despite evidence to the contrary (i.e. low valuation). Furthermore, some analysts seem to contradict what the management is saying. For example. An RBC analyst states that “ the removal of this capital-intensive and secularly challenged business is still a net positive overall for GE’s portfolio transformation.” This seems to imply that the business is at a peak rather than a trough as implied by the management. However, even if the RBC analyst is correct in that we are looking at peak earnings rather than trough earnings, then the value of GE’s share of Wabtec will decline accordingly. There is literally no way for GE to win here. If you are optimistic about GE Transportation then it’s obvious that GE left money on the table; if you are bearish then the segment’s current earnings are overstated, meaning that GE’s consolidated earnings (including GE transportation) will look even worse than it is today.