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GE earnings: Analyst explains ‘the real attraction in the stock’

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John Eade, Argus Research President and Director of Portfolio Strategies, joins Yahoo Finance Live to discuss General Electric earnings and the company's turnaround story.

Video Transcript

JULIE HYMAN: Manufacturing giant General Electric and 3M both out with earnings this morning, and the results being closely watched by the Street. Both companies plan to spin off some of their business units. 3M just announcing that today, that its healthcare business is going to separate.

Joining us with more is John Eade, Argus Research president and director of portfolio strategies. John, thanks for being here. I want to take these one by one because they're pretty different situations. So let's start with General Electric first. And the shares are up today. It looks like people are pretty happy about their aerospace results. Does it feel like, though, ahead of this separation, that General Electric has turned some kind of meaningful corner to you?

JOHN EADE: Not quite, Julie. And I'm a little bit surprised at the market's reaction today. Yes, there was a very strong earnings beat. Orders were up mid-single digits. Revenues were up mid-single digits. But cash flow-- and I think cash flow is the metric that a lot of analysts have been looking for-- while it turned positive, management scaled back its cash flow expectations for the next 12 months.

So I thought that would have been a hit on the stock. But I guess, people are confident that the restructuring is coming around. And there certainly was nice margin expansion overall, and particularly in the aerospace business. So checking some of the boxes, but not all of them yet.

BRAD SMITH: To what extent do you believe supply chain challenges that GE is citing may be more of an impairment to their business than some of the rest of the businesses that are also navigating through the same supply chain crisis?

JOHN EADE: Oh, it certainly is an issue. The supply chain is adding costs to transportation, in raw materials, in energy. And then GE has some fairly consistent businesses. Like, its healthcare business is pretty consistent. That's the one it's going to spin off first. Aviation is in a good up period now, with the 737 Max flying again and commercial aircraft recovering.

But it is those power businesses where orders are very lumpy. And so that is hard to smooth out on revenue and get costs aligned. I think they've been having problems there now for the past five or six years. And those are continuing in that group, particularly with the inflation.

BRIAN SOZZI: John, should investors just stay away from General Electric? They're going through this-- they're breaking up the company. You're seeing costs now come into the business because of this breakup. You're seeing mixed top line results across the sectors, weakening free cash flow outlook. Where's the incentive to get involved here?

JOHN EADE: So there are six areas we look at when we're analyzing a stock. And you're right. There's not a lot of excitement on growth here right now. And the financial strength isn't the best. But the valuation is pretty attractive, we think. And another factor is the management team. The CEO of GE is the former CEO of Danaher, as everybody knows. And Danaher is a long-term, long-time success story, particularly in terms of generating free cash flow.

So there still is confidence that CEO Culp can lead and accomplish this turnaround at GE. And I think that's the real attraction in the stock, you know, what he can do, as opposed to how these businesses are growing or improving.

BRAD SMITH: And Culp has drawn criticism in the past for his pay packages. So he does have many roles that he's taken on over at GE. And so with all of that in mind and so much of the conversation around layoffs or hiring freezes across industries right now, do you believe that GE is in a position to maintain its headcount? Are they going to have to trim even more so from here, even amid some of the restructuring that they're implementing?

JOHN EADE: Well, right, we saw the overall operating profit margin go from something, like, 6% to 9%, 300 or so basis points. In an era of high inflation, really, the best way to get there is to curtail your hiring or even start to lay people off.

But even at 9%, GE's margins are well, well below, say, 3M, which are around 20%, or Roper, which are around 30%. And the way to get there is to juice the top line, but in a slow growth environment, there's probably some headcount attrition we'll be seeing going forward at GE, I would assume, over the next couple of years.

BRIAN SOZZI: John Eade, Argus Research president and director of portfolio strategies, always good to see you. Talk to you soon.

JOHN EADE: Thank you.