Report created Jan 24, 2018 Page 1 OF 5 General Electric is one of the largest publicly traded companies in the world and is classified as a diversified industrials business. The stock is a component of the S&P 500 and the Dow Jones Industrial Average. Analyst's Notes Analysis by John Eade, January 24, 2018 ARGUS RATING: BUY Deep value idea GE shares have been dramatic underperformers for past year. We think the stock has been oversold during the past six months and offers value. But earnings growth is going to be difficult until at least 2019. GE continues to operate solid businesses such as Aviation and Healthcare. We now think that GE may not turn around its Power Business and reach our EPS target until 2020, and are scaling back our target price to $20. INVESTMENT THESIS Our rating on the GE shares remains BUY, but we are disappointed with the continuous string of bad news coming from the company, not to mention management's decision to cut the dividend late last year. We also think that the tactical steps management is taking to reignite growth will not likely have an impact on earnings for several quarters at least. That said, GE in 2-4 years will undoubtedly look different than the company of today. Management's strategic plan to sell up to 25% of the current portfolio and focus even more closely on important verticals of Aviation, Healthcare and Power on the surface make sense. The old management team was unable to execute and is now gone. The new management team is now under enormous pressure to produce results. Though the first few months have been rocky, we are starting to see modest improvements in areas such as cash generation. The shares also sell at value levels. RECENT DEVELOPMENTS GE shares have dramatically underperformed in recent periods. Over the past year, the shares have declined 43% while the Dow Jones Industrial Average - of which GE has been a long-time component - has gained 32%. Fourth-quarter EPS, reported January 24, fell short of estimates, but management noted that cash performance was above expectations (which is a good thing) and 'visibility and execution on cash' is improving. By the numbers, 4Q revenue declined 6% on an organic basis to $31.3 billion. GE's Data Pricing reflects previous trading week's closing price. 200-Day Moving Average Price ($) 30 Rating EPS ($) 25 20 15 Target Price: $20.00 52 Week High: $19.39 52 Week Low: $15.80 Closed at $16.26 on 1/19 Quarterly 0.21 0.51 0.32 0.46 0.23 0.28 0.45 0.66 0.25 0.30 0.48 0.72 0.27 0.26 0.27 0.28 Annual 1.49 1.07 1.03 ( Estimate) 1.08 ( Estimate) Revenue ($ in Bil.) Quarterly 28.0 33.3 29.3 33.1 28.6 29.0 29.9 33.8 29.1 29.6 32.8 37.1 0.0 0.0 0.0 0.0 Annual 123.7 121.2 128.6 ( Estimate) 0.0 FY ends Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Dec 31 2016 2017 2018 2019 BUY HOLD SELL Argus Recommendations Twelve Month Rating SELL HOLD BUY Five Year Rating SELL HOLD BUY Rating Weight Under Over Weight Weight Argus assigns a 12-month BUY, HOLD, or SELL rating to each stock under coverage. BUY-rated stocks are expected to outperform the market (the benchmark S&P 500 Index) on a risk-adjusted basis over the next year. HOLD-rated stocks are expected to perform in line with the market. SELL-rated stocks are expected to underperform the market on a risk-adjusted basis. The distribution of ratings across Argus' entire company universe is: 51% Buy, 44% Hold, 6% Sell. Key Statistics Key Statistics pricing data reflects previous trading day's closing price. Other applicable data are trailing 12-months unless otherwise specified Overview Price $16.89 Target Price $20.00 52 Week Price Range $15.80 to $30.59 Shares Outstanding 8.67 Billion Dividend $0.48 Overview Industrials Rating MARKET WEIGHT Total % of S&P 500 Cap. 10.00% Financial Strength Financial Strength Rating MEDIUM Debt/Capital Ratio 62.9% Return on Equity 12.2% Net Margin 6.2% Payout Ratio 0.47 Current Ratio 1.85 Revenue $120.55 Billion After-Tax Income $7.52 Billion Valuation Current FY P/E 16.40 Prior FY P/E 15.79 Price/Sales 1.22 Price/Book 1.92 Book Value/Share $8.78 Capitalization $146.47 Billion Forecasted Growth 1 Year EPS Growth Forecast -3.74% 5 Year EPS Growth Forecast 4.00% 1 Year Dividend Growth Forecast -50.00% Risk Beta 1.10 Institutional Ownership 56.35%
Report created Jan 24, 2018 Page 2 OF 5 adjusted operating earnings, which it calls Industrial Operating + Verticals EPS, came to $0.26, down 43% from $0.46 a year ago as the operating margin narrowed 560 basis points to 11.2%. Free cash flow of $5.6 billion represented an 81% FCF conversion rate. For the full year, revenue rose 3% to $113 billion, and adjusted EPS fell 30% year-over-year to $1.05. Along with the results, management reiterated its 2018 financial outlook for adjusted EPS in the $1.00-$1.07 range, and free cash flow of $6-$7 billion. GE continues to refine its portfolio of assets and businesses. Management commented that it had 20 deals under consideration. EARNINGS & GROWTH ANALYSIS GE breaks its operations into the following segments: Power (30% of sales), Aviation (23%), Healthcare (17%), Oil and Gas (18%), Lighting (2%), Renewable Energy (10%), Transportation (3%), and GE Capital. The businesses are fairly diversified, and growth rates vary. The fastest-growing businesses on an organic basis in 4Q17 were Oil & Gas, Renewable Energy and Healthcare. The slowest-growing segments were Power, Transportation, and Lighting. Looking out over the next few quarters, order growth has been strongest in Oil & Gas, Healthcare and Transportation equipment, and Renewable Energy, Oil & Gas and Aviation services. Power, the company's biggest segment, remains a problem. Power was viewed as a long-term growth driver when GE acquired Alstom for $10 billion in 2015. But in 4Q, revenue was down 15% and operating profit plummeted 88%. Management noted that the unit's performance was plagued by difficult market conditions, execution issues and charges. Looking ahead, orders were down 25%, indicating challenges remain. Management commented that it is implementing 'deep cost reductions' in response. This dismal performance more than offset double-digit operating profit growth in the Healthcare segment and solid performance in Aviation. Management is trying to control costs. It took out $1.7 billion in costs in 2017 and has set a goal of lowering annual operating costs by $2 billion-plus in 2018. Based on cash flow, margin and order trends, we are maintaining our 2018 forecast of $1.03, just below the midpoint of management's guidance range. Looking ahead to 2019, we anticipate modest growth to $1.08 per share. Our five-year earnings growth rate forecast is 4%. FINANCIAL STRENGTH & DIVIDEND Our financial strength rating on General Electric is Medium, the midpoint on our five-point scale. The company receives average marks on our three focus areas of debt levels, fixed-cost coverage and profitability. GE pays a dividend, which it has cut by 50%. The current annual rate of $0.48 yields about 2.8%. Our dividend estimates are now $0.48 for 2018 and $0.48 for 2019. Growth & Valuation Analysis GROWTH ANALYSIS ($ in Millions, except per share data) 2012 2013 2014 2015 2016 Revenue 146,684 113,245 117,184 117,386 123,693 COGS 74,310 79,841 83,704 82,693 87,483 Gross Profit 72,374 33,404 33,480 34,693 36,210 SG&A 32,551 17,945 16,848 17,831 18,377 R&D Operating Income 29,788 15,459 16,632 16,862 17,833 Interest Expense 12,407 2,870 2,723 3,463 5,025 Pretax Income 17,381 9,100 10,263 8,186 9,030 Income Taxes 2,534 1,219 773 6,485-464 Tax Rate (%) 15 13 8 79 Net Income 13,641 13,057 15,233-6,126 8,831 Diluted Shares Outstanding 10,564 10,289 10,123 10,016 9,130 EPS 1.29 1.27 1.50-0.62 0.89 Dividend 0.70 0.79 0.89 0.92 0.93 GROWTH RATES (%) Revenue 1.9-23.6 5.7-1.1 3.9 Operating Income -13.9-48.1 7.6 1.4 5.8 Net Income -3.6-4.3 16.7 EPS 12.2-46.4 27.0-81.9 488.2 Dividend 14.8 12.9 12.7 3.4 1.1 Sustainable Growth Rate 5.7 5.1 4.2 4.8-0.6 VALUATION ANALYSIS Price: High $28.09 $27.94 $31.49 $33.00 Price: Low $20.68 $23.69 $19.37 $27.10 Price/Sales: High-Low - 2.6-1.9 2.4-2.0 2.7-1.7 2.4-2.0 P/E: High-Low - 22.1-16.3 18.6-15.8-37.1-30.4 Price/Cash Flow: High-Low - 10.2-7.5 10.2-8.7 13.0-8.0 63.4-52.0 Financial & Risk Analysis FINANCIAL STRENGTH 2014 2015 2016 Cash ($ in Millions) 70,025 70,483 48,129 Working Capital ($ in Millions) 53,720 65,748 75,478 Current Ratio 1.48 1.63 1.93 LT Debt/Equity Ratio (%) 148.4 150.3 139.1 Total Debt/Equity Ratio (%) 204.0 201.1 179.6 RATIOS (%) Gross Profit Margin 28.6 29.6 29.3 Operating Margin 14.2 14.4 14.4 Net Margin 13.0-5.2 6.6 Return On Assets 2.3-1.1 1.9 Return On Equity 11.8-5.4 9.4 RISK ANALYSIS Cash Cycle (days) 83.6 110.0 110.3 Cash Flow/Cap Ex 2.2 1.6 0.8 Oper. Income/Int. Exp. (ratio) 4.8 3.4 2.8 Payout Ratio 54.7 59.3 178.4 The data contained on this page of this report has been provided by Morningstar, Inc. ( 2018 Morningstar, Inc. All Rights Reserved). This data (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. This data is set forth herein for historical reference only and is not necessarily used in Argus analysis of the stock set forth on this page of this report or any other stock or other security. All earnings figures are in GAAP.
Report created Jan 24, 2018 Page 3 OF 5 The company has a share buyback program but has slowed repurchases to conserve cash. The new management team, as part of the restructuring plan, will be borrowing $6 billion to prepay pension obligations for the next three years. So GE does have access to capital. MANAGEMENT & RISKS GE is undergoing numerous transitions, including a change in top management. Longtime CEO Jeffrey Immelt stepped down on August 1, and has been replaced by John Flannery, 55, who has had a long finance career at GE. In his presentation to investors in November, Mr. Flannery frequently talked about a 'focus on the core,' and a 'disciplined returns-based approach.' He is under enormous pressure to focus on generating returns in the market. His first few months have not gone well. Investors in GE shares face risks. Although GE's massive size and product diversity have helped it to smooth earnings in the past, the company's results during the 2007-2009 recession also demonstrated that it can be susceptible to a broader economic meltdown. The company also faces the challenge of large numbers, as it is difficult to grow a company that generates almost $125 billion in sales. The company's culture of continual M&A also creates risks, in addition to integration risk. In January, GE announced that a review and reserve testing for its run-off insurance portfolio will result in an after-tax GAAP charge of $6.2 billion for 4Q17, and GE Capital expects to make statutory reserve contributions of approximately $15 billion over seven years. CEO John Flannery should have had this mess cleaned up when he cut the dividend back in November. COMPANY DESCRIPTION General Electric is one of the largest publicly traded companies in the world and is classified as a diversified industrials business. The stock is a component of the S&P 500 and the Dow Jones Industrial Average. VALUATION We think that GE shares are undervalued at current prices near $16, near the bottom of their 52-week range of $16-$31. On a technical basis, the shares are now in a bearish pattern of lower highs and lower lows that dates to July 2016. The shares are barely holding on to long-time support at $24. To value the stock on a fundamental basis, we use peer and historical multiple comparisons, and a dividend discount model. The shares are trading at 15-times projected 2018 earnings, below the average of 22 for GE's traditional peer group (Honeywell, United Technologies, 3M Corp.) and at the midpoint of their own historical range. The dividend yield of about 2.8% is well above the average for traditional peers. We think GE's earnings power - with an improved Power Peer & Industry Analysis The graphics in this section are designed to allow investors to compare GE versus its industry peers, the broader sector, and the market as a whole, as defined by the Argus Universe of Coverage. The scatterplot shows how GE stacks up versus its peers on two key characteristics: long-term growth and value. In general, companies in the lower left-hand corner are more value-oriented, while those in the upper right-hand corner are more growth-oriented. The table builds on the scatterplot by displaying more financial information. The bar charts on the right take the analysis two steps further, by broadening the comparison groups into the sector level and the market as a whole. This tool is designed to help investors understand how GE might fit into or modify a diversified portfolio. P/E 25 20 15 GE Value UTX 5-yr Growth Rate(%) EMR DE MMM ITW HON DHR 5 7.5 10 12.5 Growth 5-yr Net 1-yr EPS Cap Growth Current Margin Growth Argus Ticker Company ($ in Millions) Rate (%) FY P/E (%) (%) Rating MMM 3M Co 146,704 10.0 27.2 17.7 8.6 BUY GE General Electric Co 146,472 4.0 16.4 6.2 4.9 BUY HON Honeywell International Inc 121,579 10.0 22.5 12.9 9.2 BUY UTX United Technologies Corp 108,629 6.0 20.6 8.8 3.6 HOLD DHR Danaher Corp 69,526 12.0 25.0 13.4 9.0 BUY ITW Illinois Tool Works, Inc. 59,290 10.0 25.9 16.1 9.9 BUY DE Deere & Co 54,521 8.0 21.1 7.2 12.5 BUY EMR Emerson Electric Co 46,930 8.0 25.2 9.9 12.1 BUY Peer Average 94,206 8.5 23.0 11.5 8.7 P/E Price/Sales Price/Book PEG 5 Year Growth Debt/Capital
Report created Jan 24, 2018 Page 4 OF 5 business - is closer to $1.50 than $1.00. If we apply an industry average multiple, the valuation is close to $30. We now think that GE may not reach our EPS target until 2020, and are scaling back our target price to $20. On January 24 at midday, BUY-rated GE traded at $16.47, down $0.42.
METHODOLOGY & DISCLAIMERS Report created Jan 24, 2018 Page 5 OF 5 About Argus Argus Research, founded by Economist Harold Dorsey in 1934, has built a top-down, fundamental system that is used by Argus analysts. This six-point system includes Industry Analysis, Growth Analysis, Financial Strength Analysis, Management Assessment, Risk Analysis and Valuation Analysis. Utilizing forecasts from Argus Economist, the Industry Analysis identifies industries expected to perform well over the next one-to-two years. The Growth Analysis generates proprietary estimates for companies under coverage. In the Financial Strength Analysis, analysts study ratios to understand profitability, liquidity and capital structure. During the Management Assessment, analysts meet with and familiarize themselves with the processes of corporate management teams. Quantitative trends and qualitative threats are assessed under the Risk Analysis. And finally, Argus Valuation Analysis model integrates a historical ratio matrix, discounted cash flow modeling, and peer comparison. THE ARGUS RESEARCH RATING SYSTEM Argus uses three ratings for stocks: BUY, HOLD, and SELL. Stocks are rated relative to a benchmark, the S&P 500. A BUY-rated stock is expected to outperform the S&P 500 on a risk-adjusted basis over a 12-month period. To make this determination, Argus Analysts set target prices, use beta as the measure of risk, and compare expected risk-adjusted stock returns to the S&P 500 forecasts set by the Argus Strategist. A HOLD-rated stock is expected to perform in line with the S&P 500. A SELL-rated stock is expected to underperform the S&P 500. Argus Research Disclaimer Argus Research is an independent investment research provider and is not a member of the FINRA or the SIPC. Argus Research is not a registered broker dealer and does not have investment banking operations. The Argus trademark, service mark and logo are the intellectual property of Argus Group Inc. The information contained in this research report is produced and copyrighted by Argus, and any unauthorized use, duplication, redistribution or disclosure is prohibited by law and can result in prosecution. The content of this report may be derived from Argus research reports, notes, or analyses. The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but Argus makes no representation as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. This report is not an offer to sell or a solicitation of an offer to buy any security. The information and material presented in this report are for general information only and do not specifically address individual investment objectives, financial situations or the particular needs of any specific person who may receive this report. Investing in any security or investment strategies discussed may not be suitable for you and it is recommended that you consult an independent investment advisor. Nothing in this report constitutes individual investment, legal or tax advice. Argus may issue or may have issued other reports that are inconsistent with or may reach different conclusions than those represented in this report, and all opinions are reflective of judgments made on the original date of publication. Argus is under no obligation to ensure that other reports are brought to the attention of any recipient of this report. Argus shall accept no liability for any loss arising from the use of this report, nor shall Argus treat all recipients of this report as customers simply by virtue of their receipt of this material. Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance. Argus has provided independent research since 1934. Argus officers, employees, agents and/or affiliates may have positions in stocks discussed in this report. No Argus officers, employees, agents and/or affiliates may serve as officers or directors of covered companies, or may own more than one percent of a covered company s stock. Morningstar Disclaimer 2018 Morningstar, Inc. All Rights Reserved. Certain financial information included in this report: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.