Goldman Sachs right to be bullish on General Electric?

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Goldman Sachs analyst Joe Ritchie recently described General Electric (NYSE: GE) as a “flagship idea” and set a target price of $ 16 on the stock. This was good news for investors holding these stocks, which closed at $ 12.93 on Tuesday, but is the bullish outlook justified? Let’s take a look at some of Ritchie’s assumptions and see if they stand up to scrutiny.

Image source: Getty Images.

Three points of contention

Some of the keys to the bullish record for the stock, articulated by the Goldman Sachs analyst and others, are as follows:

  • GE’s free cash flow (FCF) generation will improve dramatically over the next several years and beyond.
  • GE is strongly urged to reopen the economy, and global growth resumes.
  • The company could also help itself by managing its business better, and CEO Larry Culp is improving its performance significantly.

I think all of these bullish arguments are good and I agree that GE as a company will be in much better shape in a few years. Here’s why.

Free movement of capital

Culp believes GE is on track to generate a single-digit FCF margin by 2023 and revenue of between $ 85 billion and $ 90 billion. This combination could translate to $ 7 billion in FCF. Based on its recent market cap of $ 117.5 billion, GE would trade around 16.8 times FCF in 2023 – an attractive valuation.

Based on his commentary on the four industry segments, Culp’s goal seems reasonable. The theory is that aviation will recover based on commercial flight departures reaching 2019 levels by 2023, bringing GE Aviation to $ 6 billion in segment profit. In addition, for GE Healthcare, Culp predicts a combination of low to mid-digit percentage revenue growth and strong margin expansion, pushing this segment’s profit to roughly $ 2.7 billion. in 2020 to somewhere between $ 3-4 billion by 2023..

A plane

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Meanwhile, Culp’s expectations for GE Power to generate $ 1 billion to $ 2 billion in profit seem reasonable as it implies that the segment will achieve the high-digit profit margin percentage than its counterpart, Siemens Energy, is aiming in its electricity business in 2023. Culp did not quantify GE Renewable Energy, saying only that it would generate profits in 2023. This is understandable given that the unit’s goal is to develop its offshore wind business from $ 200 million in revenue in 2020 to $ 3 billion by 2024 while improving execution in onshore wind and turning around problematic grid solutions and hydroelectric business.

All of this should translate into a total operating profit of $ 10 billion and $ 7 billion in FCF. Longer term, Goldman Sachs believes GE could reach a double-digit FCF margin.

This is a possibility because GE has FCF growth opportunities – in particular, service revenue growth in GE Aviation (for engines on the Airbus 320 NEO and the Boeing 737 MAX) and service revenues at GE Renewable Energy (hopefully on any new wind turbines it deploys).

A gas turbine

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Self-help and leverage on the economy

GE’s self-help improvement argument applies particularly to the power and renewables segments, which management is restructuring through a multi-year process. The good news is that there are already tangible signs of progress. Coming back to the outlook meeting in March 2020, GE predicted that the FCF for the electric segment would be negative in 2020. In fact, it turned out to be slightly positive – a great result in the difficult circumstances of 2020, where access to the site has been hampered by the pandemic.

Likewise, management’s forecast for GE Renewable Energy predicted that the FCF would be worse than a $ 1 billion outflow in 2020 and remain negative in 2021. The reality was a $ 600 million outflow in 2020, and the Management now expects Renewable Energy to generate a positive FCF in 2021. In short, recoveries in these two segments are ahead of schedule.

Wind turbines

Image source: Getty Images.

As for how the company’s fortunes are used for economic recovery, GE Aviation remains the most important activity of the company. A rebound in the number of commercial flights will lead to an increase in workshop visits for aircraft and engines. In addition, GE Healthcare has a growth opportunity with a rebound in non-elective procedures, and GE Power services revenue is expected to improve as is site access.

Is Goldman Sachs Right?

In this case, the bullish argument makes perfect sense. GE appears well positioned to increase its earnings and FCF in the coming years, and based on the points discussed above, it should be an attractive stock for investors.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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