I was definitely surprised by the sharp rally of General Electric (NYSE:GE) stock. GE stock price has surged over 30% in two months, and the stock trades near $11.
I believe that weak economic conditions can impact the company’s debt reduction plans. In addition, economic weakness is likely to impact the certainty of the company’s free cash flow outlook. The global manufacturing sector is already in recession. The services sector activity has also been weakening.
Philip Shaw, the chief economist of Investec, does believe that recession fears are overdone. However, sluggish GDP growth may indicate that GE’s orders will be weak, causing its free cash flow to be subdued.
Strong Liquidity and Debt Reduction
One of the reasons for the sharp rally of GE stock is the company’s debt reduction. The company intends to reduce its net debt to EBITDA ratio to below 2.5. Its net debt declined to $49 billion in the third quarter of 2019 from $55 billion in December 2018. With more proceeds due from asset sales, its net debt will continue to decline in 2020.
The important point to note is that GE still had $16.7 billion of cash at the end of Q3 even after cutting its debt by $5.5 billion. But it obtained that cash not from healthy free cash flows, but from asset sales.
Further, the company expects additional proceeds of $29 billion from asset sales due to be completed in the coming quarters. That includes proceeds from the sale of its biopharma unit and its shares of Baker Hughes (NYSE:BKR).
The key risk at this point is that Baker Hughes stock was trading at $28.50 in March 2019. The stock has since fallen to $22.30. If the economy deteriorates further, the stock could fall more, reducing the proceeds that GE can obtain from selling shares of the company.
Debt reduction is positive and can take GE stock price higher. However, economic factors can prevent the company from meeting its debt reduction goal as soon as it and the owners of General Electric stock would like.
Aviation Remains the Key
As of Q3, General Electric had a total order backlog of $386 billion. Of the total backlog, $252.9 billion was from the company’s aviation unit. While the company’s total order backlog increased by 14% on a year-over-year basis, the aviation unit’s backlog jumped by 20%.
The aviation unit’s revenue outlook is highly dependable, and for the first three quarters of the year its profit was $4.8 billion. As the company’s power and renewable energy units continue to struggle, its aviation and healthcare units are generating cash flows.
Bloomberg recently reported that General Electric is likely to win an engine deal from Emirates. If that deal goes through, the aviation unit’s backlog will climb further.
I continue to believe that the aviation segment needs to be spun off as a separate entity. That would unlock more value for the owners of GE stock. The power and renewable energy sector have been a drag on the company’s cash flows and have negatively impacted the valuation of General Electric stock.
Final Views on GE Stock
GE stock is likely to trade sideways after its recent sharp rally. I agree that the company is better positioned than it was a few quarters ago. However, economic headwinds could negatively impact the company’s debt reduction plans and harm GE stock.
In addition, General Electric is expecting its industrial business’ free cash flow to rise in 2020 and potentially accelerate in 2021. If those targets are not met, GE stock price may move sideways to lower.
Overall, it’s best to remain cautiously optimistic about General Electric stock. A resolution of the U.S.-China trade war and expansionary government policies could improve the outlook of GE stock to positive or bullish. But at this point, I remain neutral on General Electric stock.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
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