We Went Inside the Mind of a GE Bear. Here’s What We Learned.

Barron's

Al Root

Aug 09, 2019

It is no secret that Gordon Haskett analyst John Inch is a General Electric bear. He thinks GE stock is worth $7, about 25% below current levels, and has consistently warned investors to avoid it—despite the shares’ 30% year-to-date gain. Barron’s wondered what it would take to change Inch’s mind about the company, so we asked him. The answer: A lot.

Inch’s latest research report, published on Thursday, prompted our call.

In it, Inch questions GE’s (ticker: GE) cash flow figures. He sees more cash-flow headwinds coming for the company as it ends its receivables factoring program. Factoring refers to selling accounts receivable at a discount to bring in cash sooner than it would otherwise arrive. The practice is normal and employed by many companies. GE has been winding down its factoring since late 2017.

“Excluding the impact of factoring, GE’s first half 2019 free cash flow has shown more substantial deterioration—declining by greater than $2.5 billion, versus first half 2018,” wrote Inch, who rates GE shares Underperform, the firm’s equivalent of a Sell rating.

The factoring issue is a sign of a larger problem for Inch. “I don’t think bullish investors are paying careful enough attention to all the moving parts at GE,” he tells Barron’s in an interview. “People can get confused [with GE reports]; it’s a complex company.”

GE disclosures are complicated. And that complexity might be causing investors to put too much faith in CEO Larry Culp, the leader brought in to turn around the company last September.

“Larry has done a good job, but there is no magic elixir,” says Inch. “This turnaround is going to take a long time, and existing shareholders can get hurt as it unfolds.”

In particular, he believes the company is running out of options to further reduce debt. The company plans to sell, or has already sold or spun off its rail business, energy services, and part of GE Healthcare, along with other assets. GE, however, might still have too much debt when restructuring is complete, according to the analyst. “And I still worry about the pension-funding gap and long-term care liabilities, things that aren’t recognized in the headline debt number.”

GE management has said consistently it is working to reduce leverage. GE has more than $100 billion in debt on the books. (For comparison, the company is expected to produce about $10 billion in operating profit in 2020.) Much of the debt is in the capital division. GE already took an after-tax charge of $6.2 billion in 2017 for losses arising from old long-term care policies the company retained after it spun off Genworth Financial (GNW). And GE believes its pension plans won’t require mandatory cash contributions in 2019 or 2020, meaning the plans are reasonably well funded. The funded status improved in 2018 to about 76% from about 71%.

There isn’t a brand new issue that bothers Inch. GE management has addressed debt reduction, factoring, the power division, as well as other turnaround issues many times during Culp’s tenure so far. The company has also hosted insurance and power “teach-ins” to better educate investors in 2019.

The biggest difference between Inch and more-bullish analysts seems to be how the turnaround turns out. “When it’s all done I see, maybe, 50 cents in free cash flow [per share],” says Inch. “At 16 times that number I get up to $8 a share.” Other analysts think $1 in free cash flow is possible. It’s a wide range, but GE has undergone incredible turmoil over the past two years. (The highest annual earnings per share GE reported was $2.33 in 2007.)

“Think of it this way, we’re in Act II of the GE drama,” concludes Inch. “I was right about Act I—which unfolded under [Jeff] Immelt—then Larry came on the scene, and the audience is enjoying the show.”

Using those parameters, in the first act GE stock dropped 45% and 57% in 2017 and 2018, respectively, as problems mounted in its power and capital divisions. Those problems ultimately led management to cut the dividend to a penny from 24 cents a quarter.

Inch thinks investors need to ask themselves about Act III. Is the GE story a tragedy, or modern melodrama where everyone makes out just fine in the end? Unfortunately, it’s too soon to tell, in our view. What’s clear is GE will remain a controversial stock on Wall Street until we find out.

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