Smart investors should buy falling GE shares

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Beginning of November, General Electric (NYSE:GE) announced that it would split into three separate companies focusing respectively on the aviation, healthcare and electricity markets. Investors cheered the move, pushing GE shares past $110 for the first time in months.

Since then, a variety of factors (including inflation fears, concerns over the omicron variant and continued supply chain headwinds) have crushed the stock’s momentum. Shares of GE have fallen further since the company released its fourth-quarter results on Tuesday, falling to around $90.

Performance of General Electric stock, data by Y-Charts.

This pullback represents an excellent buying opportunity for long-term investors. Continued turnaround progress, debt reduction and the company’s upcoming breakup will likely result in significant gains for GE shareholders over the next few years.

Fourth quarter results sow confusion

General Electric delivered strong overall results for the fourth quarter. Obviously, that wasn’t easy for many investors, as GE shares fell after the earnings report was released.

The main negative of GE’s results is that revenue fell 3% year over year last quarter and 2% for the full year. Management’s initial guidance called for low single-digit organic revenue growth in 2021. More recently, it had forecast revenue to be about flat for a full year.

Adding to the confusion, the industrial conglomerate released several metrics for earnings per share (EPS) and free cash flow. It didn’t have much choice as it is transitioning to a new business structure, with the remnants of its GE Capital unit no longer being treated as a separate segment. However, the change in reporting partly masked the company’s turnaround progress.

On the bright side, GE beat its full-year earnings and cash flow projections (as they stood under the old reporting system). Adjusted EPS reached $2.12, compared to an initial target range of $1.20 to $2.00. Industrial free cash flow was $5.1 billion, or $5.8 billion excluding the impact of GE’s discontinuation of its factoring programs.

Don’t Worry About Falling Revenue

It’s important to note that GE’s revenue decline was not caused by a lack of demand. The supply chain challenges crimped production, especially in the healthcare segment. Meanwhile, management is becoming even more selective in pursuing deals, sacrificing revenue growth to support earnings.

A wind turbine in a field.

Image source: General Electric.

These efforts seem to be paying off. GE’s adjusted industrial profit margin increased 3.9 percentage points on an organic basis last year. This nearly doubled its adjusted industrial profit.

Additionally, GE booked $79.4 billion in orders last year, up 12% organically year-over-year. The orders easily eclipsed GE’s organic industrial revenue of $70.2 billion, paving the way for higher revenues in the future. Indeed, management expects organic single-digit revenue growth in 2022.

Plenty of reasons to love GE stocks

Looking ahead, General Electric is poised to benefit from many tailwinds. First, it ended 2021 with the best balance sheet it has enjoyed in a long time, having reduced its gross debt by $87 billion in three years. The company’s increased free cash flow and $13 billion in investments in AerCap and hugue baker give it plenty of firepower to keep paying down debt in 2022 and 2023.

Second, GE’s aerospace business is poised for a strong rebound as air travel demand continues to recover from the pandemic and supply chain constraints ease. In the last quarter, the aviation segment generated an operating margin of 20%: in line with pre-pandemic levels. If it can maintain that level of profitability while growing revenue beyond its all-time high of $32.9 billion in 2019, GE could more than double its operating profit from the aerospace business to about $7. billions of dollars within a few years.

Third, the upcoming split into three public companies will separate the high-margin healthcare and aviation businesses from GE’s underperforming energy and renewables segments. This should unlock higher valuations for healthcare spinoffs and the remaining aerospace businesses.

GE expects to generate between $5.5 billion and $6.5 billion in free cash flow in 2022. This makes GE stock cheap based on its current market capitalization of around $100 billion. And given the strong growth prospects for aviation and healthcare units and the benefits of splitting into three simpler companies, GE’s stock looks like an absolute steal.

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

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