Stock Analysis

The Baggage Outweighs the Hype - Why General Electric (NYSE:GE) is not Self-Sufficient Yet

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NYSE:GE
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To avoid investing in a bad business, we can use a few financial metrics that can provide indications of a company destroying value. When we see a return on capital employed (ROCE) that is lower than the cost of capital, that's often a bad sign. For General Electric (NYSE:GE), we will investigate where it is struggling and how has it improved in the past.

GE has been struggling to consolidate and repair some bad decisions from their history. GE is operating in multiple segments that once looked good on paper, but failed to produce synergies, and left management struggling to excel in any direction. These segments were also operated and acquired with large amounts of debt, which the company has been painfully repaying for multiple years.

The company operates in the following segments: Aviation, Healthcare, Renewable Energy, Power, Capital.

To their credit, GE has been stabilizing the business and attempting to create value. However, This process takes a long time and there are too many loose ends before the business can be appealing again.

Check out our latest analysis for General Electric

Before looking at the current performance, we make a rundown of the productive business decisions GE made recently:

  • Cutting Dividends - Investors really don't mind a dividend cut as long as the company has a chance to revitalize and survive. GE cut first dividends in 2017 and then again in 2018. Currently, the company is paying out a token dividend but using their funds more efficiently. 
  • The campaign to reduce debt - GE had a massive U$350b debt in 2015, made from decisions that looked good only on paper. The company and shareholders have been paying for those mistakes ever since, and that is partly the reason why some investors call GE a "Zombie Company". GE has been slowly deleveraging ever since, and their bonds have currently a long-term credit default rating of BBB (Baa1, BBB+), which implies a 3.3% probability of default over 10 years.
  • Firing workers - (Note, terms like "restructuring", "downsizing", "workforce reduction", lack the common humanity people are owed when management makes mistakes and offloads the consequences on the workers) GE was overstretched for many years, and the past structure put the whole business at risk, so cutting the workers does make business sense, and may contribute to the survival of the company.

As we can see, what makes sense in business terms is sometimes costly in other ways. But if GE has any chance to become functional, it must find avenues where it can stop losing money and become self-sustainable.

Is GE a Creating Value?

Now we are going to look at how has the revitalization of the company been progressing, and see if GE makes more sense for investors today.

For that we are going to compare the return on capital employed to the cost of capital.

Estimating the cost of capital gives us a threshold which the company has to surpass in order to be creating value as a business - it's like having a minimum passing grade.

Companies that do not deliver returns on capital that are higher than the costs for an extended period of time, inevitably lose value and the share price can suffer.

For GE, given their debt rating, country risk premium and industry segments in which they operate, we can estimate a cost of capital at 6.1%. This is fairly low, and reflects the benefits of being a mature company. 

The other side of the story are the returns on capital, so let's see how well GE has been deploying capital.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business.

The formula for this calculation on General Electric is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.0099 = US$1.8b ÷ (US$237b - US$58b) (Based on the trailing twelve months to September 2021).

Therefore, General Electric has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Industrials industry average of 8.0%.

Comparing to their cost of capital of 6.1%, we see that GE significantly lacks in performance and is still destroying value as a company.

roce
NYSE:GE Return on Capital Employed November 2nd 2021

In terms of General Electric's historical ROCE trend, it isn't fantastic. The company used to generate 3.1% on its capital five years ago, but it has since fallen noticeably. It has been recovering in the last three years, but has still a long way to go before becoming self-sufficient.

Key Takeaways

GE is slowly and painfully stabilizing the fundamental performance of the company. It has made some hard but necessary decisions to consolidate the business in the past, which may give them a viable path to recovery.

The return on capital is lower than the cost of capital, which indicates that the business is still destroying value, and their baggage from the past may outweigh any recent hype events.

Long-term shareholders who've owned the stock over the last five years have experienced a 49% depreciation in their investment, so it appears the market might not like these trends either.

General Electric does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is potentially serious...

While General Electric isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

What are the risks and opportunities for General Electric?

General Electric Company operates as a high-tech industrial company in Europe, China, Asia, the Americas, the Middle East, and Africa.

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Rewards

  • Trading at 51.2% below our estimate of its fair value

  • Earnings are forecast to grow 52.6% per year

Risks

No risks detected for GE from our risks checks.

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Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Goran Damchevski

Goran Damchevski

Goran is an Equity Analyst and Writer at Simply Wall St over 4 years of experience in financial analysis and company research. Personally, Goran has over 4 years of experience in financial analysis and company research, where he previously worked in a seed-stage startup as a capital markets research analyst and product lead and developed a financial data platform for equity investors. 

About NYSE:GE

General Electric

General Electric Company operates as a high-tech industrial company in Europe, China, Asia, the Americas, the Middle East, and Africa.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation4
Future Growth3
Past Performance0
Financial Health4
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Good value with adequate balance sheet.