On Friday, General Electric (NYSE:GE) reported adjusted earnings per share of $0.19 for the second quarter, edging past the average analyst estimate. Yet the company’s second consecutive quarterly earnings beat didn’t lift the stock. Instead, GE shares have fallen back to around $13, near the multiyear lows reached earlier this year.
The most recent setback for GE stock was driven by further management commentary indicating that it will take years to turn the troubled power business around. General Electric also said that 2018 EPS and free cash flow will likely come in at the low end of the company’s initial guidance ranges. However, investors are overreacting to this bad news — most of which wasn’t really news — while ignoring the continued strength of GE’s aviation and healthcare units.
General Electric’s second quarter, by segment
The struggles of GE’s power and renewable energy businesses continued last quarter. Orders plunged 26% in the power segment, while revenue fell 19% and segment profit plummeted 58% to $421 million. Meanwhile, orders fell 15% in the renewable energy segment — though that was driven by order timing — while revenue fell 29% and segment profit went down 48% to $82 million.
The oil and gas segment, which consists of publicly traded Baker Hughes, a GE Company (NYSE:BHGE), saw orders, revenue, and segment profit all nearly double year over year. However, those increases were driven by the merger of GE’s oil and gas business with Baker Hughes, which went into effect last July.
On an organic basis, oil and gas orders increased 2% year over year, but revenue was down 12% and adjusted segment profit fell 27%. Fortunately, there are growing signs that higher oil prices are finally stimulating a turnaround in demand for Baker Hughes’ equipment and services.
Aviation and healthcare remained the bright spots last quarter. Aviation orders surged 29% and revenue increased 13% year over year in Q1. Segment profit rose 7% to $1.5 billion despite modest margin pressure related to a major product transition. In healthcare, orders and revenue increased 7% and 6%, respectively. Segment profit jumped 12% to $926 million.
Among GE’s smaller segments, the transportation division logged a 42% increase in orders, but revenue and segment profit both fell by double digits. In the lighting division, segment profit increased 41% to $24 million, despite a 28% drop in orders and a 9% revenue decline. Finally, the ailing GE Capital business posted a $273 million loss for the quarter.
GE’s plan to slim down is progressing
Last month, management presented a plan to improve GE’s performance by breaking up the conglomerate (more or less). General Electric had already planned to sell its transportation and lighting segments, as well as noncore pieces of its other businesses. During the presentation last month, GE confirmed plans to exit its stake in Baker Hughes over the next few years, while spinning off the healthcare division as a stand-alone public company.
GE’s asset sales — excluding the healthcare and oil and gas businesses — will raise about $10 billion of cash that can be used to pay down debt. The healthcare spinoff will assume another $18 billion of debt and pension liabilities.
Together, the Baker Hughes stake and the parts of the transportation and healthcare divisions that will be spun off to GE shareholders are probably worth $7 to $8 per share. Thus, investors are valuing the part of GE that will remain inside the conglomerate at $6 per share or less. That seems absurdly low.
Investors are looking the wrong way
All things considered, GE’s second-quarter performance was solid. While the power unit is still suffering from moribund demand, there weren’t any nasty surprises in the GE Capital unit. On the flip side, the healthcare division’s strong growth continued, increasing the value of this future spinoff. Meanwhile, the aviation division is positioned for a decade or more of rapid growth.
The healthcare and aviation segments posted a combined profit of $2.4 billion last quarter. This compares to a combined segment profit of around $500 million for the power and renewables units. As long as the healthcare and aviation businesses continue their steady growth, volatility in the power and renewables businesses will have a minimal impact on GE’s long-term results.
Furthermore, while GE Capital posted a sizable loss last quarter, that was driven by the timing of various charges and asset impairments. Management expects GE Capital to break even this year (roughly speaking).
GE’s breakup plan will generate lots of cash to address the company’s weak balance sheet, so minor changes in the near-term outlook for the power business — or for corporate-level EPS and free cash flow — don’t matter much anymore. The case for GE stock is based upon the massive long-term growth potential of the aviation and healthcare franchises. That investment case seems as strong as ever, and over the next few weeks, I will look to increase my stake in this deeply misunderstood company.