Even GE Stock Bears See Value in the Aviation Unit -- Barrons.com
By Al Root
Wall Street is asking what GE Aviation -- General Electric's best-performing division -- is worth after the company hosted its investor event at the biennial air show outside of Paris.
Wall Street opinions on GE stock (ticker: GE) are quite polarized, so it isn't surprising that opinions regarding the value of GE Aviation are wide-ranging too.
Bearish analysts from brokerages JPMorgan and Gordon Haskett value the aircraft-engine unit at $50 billion to $60 billion, while others have suggested GE aviation is worth up to $100 billion. In Wednesday morning trading, GE stock is at $10.49, giving the company a total market cap of $89 billion and a market value of $134 billion including net debt.
The back story. Analyst target prices on GE stock are incredibly wide ranging, from $5 to $15 a share. The $10 range, about 100% of the stock's current value, is indicative of an unusual situation on Wall Street.
Many bullish analysts justify their price targets using a so-called sum-of-the-parts approach, which values each division separately and adds them together. That is a sensible approach when one large division, such as GE Power, is struggling and dragging down the results of the entire entity.
Bearish analysts prefer to value the stock by looking out to 2020 or 2021 and estimating what GE will earn when the turnaround being led by new CEO Larry Culp is complete. The bears are skeptical that total cash flow and earnings will improve enough to justify today's stock price.
To generate a number for GE Aviation, JPMorgan analyst Stephen Tusa recalculates GE Aviation's $4.2 billion in reported 2018 free cash flow and cuts the number by 55%. "Inflated segment free cash flow definition misrepresents underlying cash generation of [GE Aviation]," contends Tusa. He makes various deductions for inventories and corporate costs. Tusa sees the maximum value for GE Aviation at $60 billion.
Gordon Haskett analyst Jonh Inch thinks GE Aviation is worth only $50 billion and bases his number of the exchange ratio of the United Technologies (UTX) and Raytheon (RTN) megamerger. That's is a complicated calculation because the deal involves a number of moving parts. United Technologies must spin off its elevator and air-conditioning unit before completing the Raytheon deal. Analysts can guess what the former United Technologies standalone units will be valued by the marketplace, but the actual value won't be apparent until the first half of 2020 when deals are struck.
Both Tusa and Inch have sell ratings on GE stock with respective target prices of $5 and $7.
Citigroup analyst Andrew Kaplowitz is more bullish about GE Aviation. "We see GE Aviation as the continued leader in GE's transformation given its stability and underlying growth," writes Kaplowitz in a Wednesday research report adding that it's "hard to poke holes in a strong Commercial Aviation portfolio." He rates GE shares at Buy and has a $14 target price.
Looking ahead. For the bulls and the bears, GE Aviation free cash flow is an important metric, but the problem for investors is it can be volatile, especially in a long-cycle business like aviation where assets are sold at cost and cash flow gets generated over the next 30 years.
The simplest way to value GE Aviation may be to look at peers on a price-to-sales basis. Of course, profit margins, earnings and cash flow matter a great deal when valuing any company, but total sales is one sanity-check investors can use which eliminates the need to dive into working capital, international tax policy, or corporate cost allocations.
Engine maker Safran (SAF.France) is a 50/50 partner with GE in joint venture CFM International, which makes the LEAP and CFM56 engines. Safran generates about $23 billion in sales and has a market value, including debt of more than $67 billion for a ration of about 2.8 times. MTU Aero Engines (MTX.Germany), United Technologies' partner on the geared turbofan engine, trades at a 2.4 times multiple of sales. Rolls-Royce (RR.London) -- a maker of engines and not the cars -- trades for 1 times sales, but Rolls-Royce has been losing money in recent years. At the higher end of valuation multiples, aircraft-engine components maker Woodward (WWD) trades for 4 times sales. A sales multiple -- in the middle of the range -- of 2.5 times -- values GE Aviation at almost $80 billion.
For its part, GE seems pleased with how things went in Paris. The company referred Barron's to its volume of business at the show (engine orders hit $52 billion Wednesday morning). The company also confirmed that the newest engine products generate less cash flow early in their service lives while declining to go into details.