A General Electric wind turbine
Sebastien Bozon/AFP via Getty Images
Thursday, General Electric management took investors on a deep dive into its embattled power business at an analyst event taking place just outside Greenville, S.C. The power and renewable-energy business could be pivotal to how GE stock performs in coming years.
GE (ticker: GE) is on its way to break up into three companies: One dedicated to healthcare, another to aviation, and a third dedicated to power generation. The valuation and outlooks for healthcare and aviation are less controversial on Wall Street compared to the power business.
Numbers show why. GE Aviation has generated positive annual profits as far back as investors want to look. The business even generated about $1.2 billion in operating profit in 2020, during the depth of Covid-19 lockdowns. The healthcare business also demonstrates consistent profitability. Healthcare generated almost $10 billion in operating profit over the past three years, combined.
The power business is more challenged. Power and renewable-energy businesses combined have lost about $2 billion on an operational basis in the last three years. The power segment, which includes natural-gas power-generation turbines, had sales of $16.9 billion in 2021, but operating-profit margins have ranged from positive 14% to negative 5% over the past six years. Renewable energy, which includes wind turbines, had sales of $15.7 billion in 2021; but it hasn’t produced a full-year profit in the last three years, and operating-profit margins have averaged about negative 5% over that span.
There’s a lot of complexity inside those two businesses, both of which will form the basis of the new GE Power that will spin off as a separate entity in early 2024. The business will include onshore and offshore wind turbines, natural-gas turbines, carbon-capture technology, a nuclear business, as well as grid-resiliency and transmission technologies. What’s more, the electricity-generation industry could grow 50% by 2040.
But GE’s natural-gas power business has been shrinking over the past couple of years. That’s something GE believes will turn around in 2022. Demand growth in the onshore wind-turbine business is stable over time, but changing tax-credit policy in the U.S. creates a boom-and-bust cycle for installations. The offshore wind-turbine business grows rapidly, but it isn’t profitable yet. GE believes profits will come by 2024.
There are a lot of moving parts. Adding it all up, GE expects the power business to generate about $1.1 billion in operating profit in 2022 and another $1.5 billion in 2023. Profits like that imply profit margins of about 5% in 2022 and 8% to 10% in 2023. In the long run, GE sees the business growing at a low-single-digit percentage annually. Earnings should grow faster than sales.
All the volatility and complexity creates a “trust me” dynamic when evaluating management guidance—another reason why valuing the coming business is difficult to do.
Peer multiples don’t help all that much either. Shares of electrical-component supplier Eaton (ETN) trade for about 16 times estimated 2023 operating profit. Shares of Mitsubishi Heavy Industries (7011.Japan), another turbine maker, trade for about 12.5 times estimated 2023 operating profit. Wind-turbine players trade for roughly 30 to 40 times estimated 2023 operating profit.
Those multiples, along with potential profit-margin improvement, can yield a value of the power business of anything between $15 billion to $40 billion, or roughly 0.5 to 1.3 times sales. The $25 billion spread is worth about $23 a share and works out to 25% of the current price of GE stock.
The good news is that Wall Street is at the low end of that range for the power business, with analyst estimates ranging from $10 billion to $20 billion. (The weighted average is closer to $20 billion.) Any improvement in sentiment for that business can drive upside to GE target prices.
Sales and profit-margin momentum will be key for improving sentiment. Breakthroughs in sustainability, such as carbon-capture technology, could help as well. That’s what GE bulls hope for.
Coming into Thursday trading, GE stock has declined about 3% year to date, better than the 10% and 8% respective declines of the S&P 500 and Dow Jones Industrial Average. Shares are down 16% since the company announced its plans back in November; the S&P 500 is down about 9% over the same span.
Write to Al Root at [email protected]
