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Aviation Is the Rope in the Tug of War Over GE Stock

Vince Martin

After a big rally, General Electric (NYSE:GE) stock has stalled out. General Electric stock has traded sideways for about a four and half months now, staying mostly in a range between $9 and $10.25.

The Valuation of General Electric's (GE) Aviation Unit Impacts GE Stock

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It’s not terribly difficult to see why that is. After a long decline over the last few years – including two dividend cuts – investors and analysts don’t entirely trust General Electric stock. To some, including InvestorPlace columnist Dana Blankenhorn, GE’s debt and pension liabilities suggest years of pain ahead. To others, the long-awaited turnaround is at hand.

Increasingly, it seems like it will be GE Aviation that determines whether the bulls or bears will prove correct. That’s not terribly surprising, of course: Aviation is GE’s most profitable, and likely its most valuable, business. It generated roughly 60% of the company’s segment-level profit last year, according to General Electric’s 10-K filing.

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But the gap between bulls’ and bears’ views of what Aviation truly is worth appears to be widening.  The issues at Boeing (NYSE:BA) add a dose of uncertainty to the debate. Skeptics and believers see the unit’s performance at the recent Paris Air Show very differently. Indeed, they see the future of the unit very differently.

Heading into the second half of 2019, with GE’s Q2 earnings two weeks away, it seems likely that the continuing argument over GE stock is going to come down to GE Aviation.

A Big Win for GE Aviation

On its face, the Paris Air Show last month – the industry’s biggest event – seems like a win for General Electric. GE Aviation and its joint venture booked a record combined $55 billion in orders, per a company press release. That was up from $31 billion the year before.


Obviously, that $55 billion isn’t turning into revenue in 2020  or even necessarily by 2025. But with commercial aircraft demand still strong, it suggests that GE Aviation at worst is keeping pace with competing engine builders. That notably includes United Technologies (NYSE:UTX) unit Pratt & Whitney, which has taken market share in recent years.

Meanwhile, the merger of UTX and Raytheon (NYSE:RTN) potentially creates a more formidable competitor on the defense/military side as well. And the delays of GE’s new GE9x turbine engine hampered Boeing’s launch of its 777x. After that news, and with its competition improving, GE Aviation needed a strong showing – and got it.

Right?

General Electric Stock Stays Stuck

Perhaps. But GE stock bears weren’t so sure  and apparently, neither were investors. Even as stock markets raced to all-time highs, the lid stayed on GE stock.

And two noted skeptics cast doubt on the headline. Stephen Tusa, who has been a prescient bear on GE stock for years now, went as far as to call the order figure “a smoke screen.” He argued that new engines – including the GE9x and the LEAP, the latter of which is manufactured in a joint venture with Safran SA (OTCMKTS:SAFRY) – might not be as profitable as GE’s past models.

John Inch of Gordon Haskett seemed to agree. Both analysts argued that the unit’s 2018 earnings – and remember, 2018 was a disastrous year for GE as a whole – were likely above its long-term averages. As a result, Tusa argued that GE Aviation was worth potentially less than $40 billion, with Inch citing a $50 billion ceiling.

Of course, as Barron’s noted, other analysts saw it differently. Both Citigroup  and Barclays  saw the order growth as impressive. Those analysts are among the bulls who value GE Aviation in the range of $80 billion -$100 billion.

Those differing valuations have an enormous impact on GE stock.

What Aviation Means for GE Stock

What seems to be a $30 billion-$60 billion discrepancy on Aviation’s valuation leads to very different views on GE stock. On its own, that range suggests a $3.40-$6.80 per share impact to a “sum of the parts” model.

But that’s not the only impact. Again, GE has a huge amount of debt. A stronger Aviation business will produce more cash flow that can be used to pay down that debt. It also gives GE more ways to raise money; a spin-off or partial sale of the unit can be used to raise capital, for instance.

A weaker Aviation business, however, leaves GE in something close to trouble. The Power business still is a mess. GE Healthcare’s profits are coming down after the company sold GE Biopharma to Danaher (NYSE:DHR) for $21 billion. Aviation matters not just in terms of paper valuation; it has to drive much of the growth and cash flow that GE needs to create.

The importance of Aviation can be seen in the relative price targets of the four analysts, as Barron’s pointed out. Tusa and Inch value General Electric stock at $5 and $7, respectively. Barclays sees GE stock getting to $13, and Citigroup  estimates that GE stock is worth $14 per share.

On the Sidelines

A weaker Aviation business would be bad news for GE stock. I argued last year in a detailed analysis that GE, in a breakup, likely was worth at most $14-$16 per share. Including the costs of a breakup, its value is something closer to $9-$11. That was based on an estimated valuation of Aviation, using its 2017 results, of nearly $100 billion.

Not all that much has changed since then, though the arrival of new CEO Larry Culp has sparked optimism towards the company’s future. But if Aviation “really” is a $50 billion or a $70 billion business, it gets tougher to argue that GE stock can rise. And given that I’m skeptical that the 737 MAX issues – which already are expected to hit GE’s cash flow by $200-$300 million – will be resolved soon, I’m not expecting investors’ sentiment towards the unit to improve much as the year goes on.

As I’ve written before, I’m rooting for GE stock. It’s an iconic American company, and I’d love for long-suffering shareholders to see a rebound.

But its problems are real. Its current collection of businesses isn’t all that attractive anymore. General Electric stock needs Aviation to be a big winner – and if there are any signs at all that it won’t be, it gets very difficult to pound the table for GE stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

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