A GE Stock Bear Trashed the Aviation Unit. Heres Why Investors Shouldnt Worry. -- Barrons.com
By Al Root
The bears are at it again. This time sounding the alarm on General Electric's most highly valued division: Aviation. JPMorgan analyst Stephen Tusa believes investors are too optimistic about the long-term prospects for GE Aviation. Just how overly optimistic? His aerospace valuation is below his Wall Street peers -- by a whopping $70 billion. That's almost equal to the entire market capitalization of the 127-year old company founded by Thomas Edison.
"After an in-depth review of structural dynamics around the fundamentals and financials, we stand by our view that GE Aviation offers materially less growth with greater risk," writes Tusa in a 92-page research report published Friday. "The point is that a simplified carve-out value used in an SOTP analysis based on Aviation Ebitda and related peer multiples is too generous when measuring value." He rates GE stock (ticker: GE) at Sell with a $5 price target, the lowest on the Street.
Ebitda is short for earnings before interest, taxes, deprecation, and amortization. SOTP is short for sum-of-the-parts valuation, which is often favored by Wall Street when evaluating complex conglomerates
And GE is complicated. The iconic American manufacturer has a large finance arm, GE Capital, as well as health care, power, and aviation units. SOTP analysis is used by many analysts, including Tusa, who cover GE.
For GE Aviation, analysts as well as investors have a large, publicly traded comparable company to look at for comparison: Safran (SAF.France). GE and Safran actually make engines together in their 50-50 CFM partnership. The pair, for instance, make the LEAP engine that powers the Boeing (BA) 737 MAX. CFM engines competes with United Technologies (UTX) unit Pratt & Whitney.
Safran stock trades for 20 times 2020 estimated earnings, 2.3 times estimated 2020 sales of about $18 billion and generates 15% operating profit margins. GE Aviation, for comparison, generates about $31 billion in sales and roughly 20% operating-profit margins. At the Safran multiple of sales, GE Aviation is worth more than $70 billion. But GE Aviation is more profitable than Safran -- investors, after all, are paying for profits and not for sales -- which is why some on Wall Street value the division at up to $100 billion -- more than the current market value of GE. (Don't forget, GE has debt and pension obligations, and a $100 billion aerospace valuation is only a part of the GE value equation.)
To be sure, Tusa's paltry $30 billion valuation for GE Aviation is an outlier. Wolfe Research analyst Nigel Coe, for instance, estimates GE Aviation is worth up to $99 billion based on 11.5 times estimated 2021 Ebitda. Shares of most industrial businesses in the S&P 500 trade at between 10 and 12 times next year's estimated Ebitda. Coe rates GE stock at the equivalent of Buy with a $14 price target.
There's another problem with Tusa's low valuation GE Aviation. If the unit really is worth only $30 billion, then the entire sector has a problem. Valuations for a merged United Technologies and Raytheon (RTN) are predicated, in part, on looking at comparable companies such as GE and Safran. What's more, aerospace is a strong industrial end market that's holding up better than others such as the automotive manufacturing. Global light-vehicle sales are shrinking currently.
"There's about 5% more people on planes every year pretty consistently," explains T. Rowe Price capital-appreciation strategy portfolio manager David Giroux to Barron's. The consistent growth manifests itself in stock-price performance. Aerospace suppliers that Barron's tracks are up almost 30% year to date, better than the gain of the Dow over the same span.
Tusa counters in his report, "GE Aviation is worst positioned among aero-engine peers from a growth and balance-sheet perspective and deserves a discount to Safran and its approximate 5% FCF yield." He think GE Aviation has its own issues, including falling market share and aftermarket services mix.
GE, however, is a broader, more-diversified aerospace supplier than Safran. That's usually a good thing for investors. GE, for its part, feels pretty good about aviation. A spokeswoman pointed Barron's to second-quarter results in the aerospace unit. More than 60% of aviation revenue is aftermarket, backlog was $244 billion, up 9% sequentially. More than $200 billion of the backlog was in services supported by an installed base of 68,000 engines.
Tusa's report isn't likely to move GE stock all that much. Shares are already embroiled in an epic bull-bear debate. Analysts' price targets range from $5 to $15 a share, a spread which is almost three times as wide, percentage-wise, as the typical stock in the Dow Jones Industrial Average. Still, the impact is being felt Friday. GE stock is at $8.64 down 8 cents, or 0.86%, while the Dow is up 0.7%.
For the year, both bullish and bearish analysts can claim victory -- sort of. GE stock is up almost 20% year to date, better than the gain of the Dow, but the stock is also almost 30% lower in the latest 12 months.