In the past General Electric (NYSE:GE), like most companies was valued based on earnings or cash flow. However, the former and current CEOs have stated significant portions of the company will be sold, spun-off or monetized in other ways. That indicates the best way to value the company now is a sum of the parts.
This calculation has been recently done by others, though in the case of stock analysts, the actual calculation is not available to the public.
On October 9, 2018, Nicholas Heymann of William Blair determined a sum of the parts valuation of $14.60 to $16.78 per share.
On June 27, 2018, Seeking Alpha’s DoctorRx determined a sum of the parts value of at least $18 per share, before further deterioration.
Here is my market value analysis by segment:
The aviation segment, which focuses on jet engines, is the crown jewel. Like Amazon Web Services to Amazon, it is probably worth at least half of all of GE. Revenues are growing 10% per year. What is particularly inviting to investors is future revenues are very predictable due to a huge backlog that goes well into the future. Investors love predictable income streams. The Aviation segment had revenues of $22.1 billion in the first nine months of 2018 and operating income of $4.74 billion. Annualized operating income is $6.32 billion. Less 20% for taxes, net income is $5.06 billion. To determine a proper PE ratio, GE aviation was compared to other large aerospace companies.
Sources: Value Line, Yahoo Finance and forms 10-Q.
As shown above, the aerospace industry gets an above average PE ratio, despite below average revenue growth. I attribute this to the huge backlogs which allows investors visibility well into the future, unlike most other industries. HEICO appears to be an outlier. Excluding HEICO, the peer trailing PE ratio is 21.9. GE aviation has a 10% revenue growth rate, significantly above peer average. Boeing, its largest customer, is the best comparable. Based on the comparables, especially Boeing, I believe a PE ratio of 25 is appropriate. With a post-tax annualized earnings of $5.06 billion, the value of GE aviation is $126.5 billion.
GE Power along with lighting is one of GE original businesses. In fact, GE essentially invented this business. Until recently it was GE’s largest business. GE Power had revenues of $20.5 billion in the first nine months of 2018, and $5.7 billion in the last quarter. Revenues were down 21% year to date and 33% in the last quarter. This division lost $631 million in the last quarter and made $64 million for the year. This segment is one of the main reasons it is difficult to value GE based on a PE ratio right now. This is a large business that still has lots of value but is currently reducing overall earnings. That means it is reducing market value if you use a PE ratio, when in fact it still adds to value.
This segment is hard to value as it has no pure play competitors. Siemans is in this business. Its segment in power had revenues of 3.64 billion euros in the fiscal year ended September 30, 2018, down 8% from a year earlier. This confirms that GE’s problems are industrywide not specific to GE. However, Siemans revenue decline was much less than GE’s. Siemans is not a good comparable for value as the power division is only about 12% of the total.
Mitsubishi Heavy Industries (OTCPK:MHVYF) is probably the closest to a pure play. It had revenues of $36.1 billion last fiscal year ended March, 2018. The stock currently trades at 36.5% of that. GE Power has historically had a profit margin 3-4 times higher than Mitsubishi.
For other comparables, I looked for industrial companies that have declining sales and earnings.
Sources: Value Line, Yahoo Finance and forms 10-Q.
All three shown above are industrial companies or construction companies. Briggs & Stratton is a small engine company that is facing increased competition from lower cost overseas companies. Flowserve and Fluor are diversified but have a lot of exposure to the oil and gas industry. Fluor is a construction company. These routinely have lower profit margins and lower price to sales than average. GE Power has underperformed all three recently but has more recurring revenue by far. Based on Mitsubishi, Briggs & Stratton and Fluor I estimate GE Power to be worth 40% of revenues. I placed it a bit higher than those three due to close to 50% of GE Powers revenue currently from recurring service contracts. Revenues totaled $20.5 billion in the first nine months of this year. Assuming the fourth quarter is the same as the third, annualized sales are $26.3 billion and market value is $10.5 billion.
A second methodology was used based on earnings power. GE Power earned between $4 to $5 billion in operating income during 2013-2016 with operating profit margins of 13-16%. That indicates earnings power is much higher than what is happening today. This industry is facing a secular headwind from renewable power and may not be again what it was in that heyday. Assuming a new lower revenue rate of $25 billion, down from $36.8 billion in 2016, and an operating profit margin of 12%, operating profit potential is $3 billion a year. That is $2.4 billion after a 20% tax. If business is permanently reduced, then GE will right size the company to get to this profit margin. However, that will take time. Based on the time needed to right size and the revenue decline a PE ratio of 8 is currently appropriate. That values the segment at $19.2 billion.
The two methodologies I used show very different values. Putting a two thirds weight on the comparables, my market value for GE Power is $13.4 billion.
GE is selling its transportation division to Wabtec for $2.9 billion in cash plus 50% of Wabtec stock. Wabtec had a market cap of $8.14 billion on November 13, 2018. This indicates GE’s portion is worth the same, plus the cash. GE sold this business at what appears to be a cyclical low in the industry. While not good for GE now, it bodes well for the future.
Healthcare revenues were $14.38 billion for the first nine months of 2018, up 5.0% from one year earlier. Operating income was $2.52 billion over that period, up 8.0%. However, revenues and earnings stalled in the most recent quarter. Operating income is $3.36 billion annualized and $2.68 billion after assuming a 20% income tax rate. The Healthcare segment when spun off is expected to carry a projected $18 billion of debt, including pension obligations.
The comparables used below are large healthcare equipment companies. Those with significant acquisitions were excluded.
Johnson & Johnson (NYSE:JNJ) deserves a lower PE because a lot of its revenues come from drugs with patent expirations. It also has lower growth. Boston Scientific (NYSE:BSX) and Stryker (NYSE:SYK) have better revenue and earnings growth. Medtronic (NYSE:MDT) is probably the best comparable. Though its product line is different, the growth profile and size is similar. Based on the comparables, a PE ratio of 19 is determined. This puts market value of $50.92 billion.
This segment primarily deals with wind power. The best comparable is Vestas (OTCPK:VWDRY) which is a pure play in this field and the largest player. Vestas had revenues of 6.77 billion Euros in the first nine months of 2018, down 1% from the prior year. Net profit was 464 million Euros for a 6.8% profit margin. It currently has a market cap of $12.8 billion euros for an annualized PE ratio of 20.7. GE’s Renewable Power segment is much less profitable. Revenues totaled $6.71 billion for the first nine months of 2018 with an operating profit of $220 million. The profit margin is less than half that of Vestas after taxes. Vestas trades at 1.42x sales. GE with half the profit margin should trade at about half Vestas price to sales. That puts the market cap at $6.35 billion. However, being in the exact same business, a premium needs to be given to GE Renewable Power as it has more upside than Vestas which is currently maximizing profits better. My estimate for GE Renewable Power is $7.5 billion.
This one is quite simple. GE owns 62.5% of Baker Hughes (NYSE:BHGE) and is in the process of selling down to a 50% ownership. Baker Hughes is publicly traded currently and had a market cap of $26.53 billion on November 13, 2018. GE’s portion is $16.58 billion.
GE Lighting is for sale. It had revenues of $1.27 billion for the first nine months of 2018, down 10% from the prior year. Operating earnings were $52 million, up 27% over the same period. Lighting is a struggling industry right now due to declining pricing and most competitors are also struggling. Acuity is a pure play and also the largest lighting company in the U.S. It currently trades at a trailing PE ratio of 14. Acuity has a better profit margin and better growth than GE Lighting. Revenue growth has averaged 9% over the past three years, though its now closer to 4%. Based on Acuity, a PE ratio of 12 is appropriate for GE Lighting. After a 20% income tax, that puts market value at $832 million.
GE Capital is primarily comprised of by revenues of; aircraft finance 48%, insurance 28%, energy financial services 12%, industrial and other 12%. This segment lost $106 million from continuing operations in the first 9 months of 2018. The insurance portion is primarily long term care insurance. This insurance is no longer offered by many former providers due to increasing losses. Earnings in each segment are not broken out. So a comparison using a PE ratio or cash flow is not available. Many financial companies are valued in part by book value. Tangible book value of GE Capital was $9.00 billion on September 30, 2018. GE has agreed with regulators to pump $11 billion into its insurance subsidiaries through 2024, due to long term care losses. That is $2.2 billion per year. Discounted at 5% (their long term bond rate), the present value is $9.5 billion. This exceeds tangible book value. For this reason, I assume no value for GE Capital.
Market Value: Sum of the Parts
Values were determined above pus liabilities and other assets are totaled below.
Sources: Calculations above; September 2018 10-Q.
Based on a sum of the parts, GE is worth $16.35 per share. This is similar to the recent William Blair calculation. As a general rule, companies trade at a discount to a sum of their parts, especially conglomerates. This is partially offset by the fact the GE is dividing itself up with plans to spinoff Healthcare, sell lighting, and sell part of transportation and Baker Hughes. Since GE is in the process of monetizing large portions of its business, a 15% discount is assumed, versus larger discounts usually used. That puts current value at $13.90.
The important thing to note is that only parts of GE are struggling. The aviation segment alone is worth over half of the market value and is doing very well. In my opinion, the stock is down for two primary reasons. They are; an avalanche of bad news over the past year and the dividend cut. The dividend cut specifically is causing dividend investors to sell and temporarily putting further downward pressure on the price. GE used to be a dividend investors staple so the exodus will be significant. It should also be noted there is a new sheriff in town and sale and spinoff plans could change.
I recommend a long position in GE with a price target of $13.90.
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.