The stock of General Electric (NYSE:GE) is swiftly getting closer to my fair value estimate of $12.5, and I stick to that price target based on its fundamentals, trading multiples and consolidated liabilities.
But there are rising risks to my estimates.
Downside risk from $14.7 a share?
Whether you like it or not, now we are about to reach a point where persistent weakness in its share price could lure opportunistic financiers with deep pockets and strong ties in the finance world. Flipping GE Capital’s assets and liabilities to trade buyers could be easier than many pundits think.
How not to mention Warren Buffett, for example, who recently said he would be interested in GE’s “little pieces”?
I mean, if you came to me and said we’ll sell you the whole General Electric Company and ‘X’ was the right price number, we would like to buy it if we buy little pieces in the market, that’s the way we think about it,” Mr. Buffett told CNBC in early January.
Asked about a possible “price target if you have one,” he calmly replied:
Yeah. Well, that would depend also on what other stocks were selling (…) my job is to have the capital of Berkshire invested in businesses that we think we understand pretty well, and that are an attractive valuation. Now, we can’t move around in big positions that easily. It takes pretty big disparity from something we want to sell to move to something we want to buy. General Electric is a big strong company.”
So give it a year before Mr. Buffett, with the backing of a trade buyer of course given GE’s size, possibly makes his move – anyway, stock prices, in these situations, move well before the real action takes place.
“Hi Mr. Buffett, I’m calling about GE”
I still expect $1.1 a share of industrial EBIT for its core operations in 2018, which implies a total operating income of $9.6bn.
Based on its historical/projected depreciation and amortization profile, it is fair to assume a normalized level of EBITDA hovering around $15bn this year and next, excluding minimal contributions from GE Capital.
In late 2016, Bloomberg reported that Berkshire Hathaway’s (BRK.A) (BRK.B) 2009 purchase of Burlington Northern Santa Fe (BNSF) valued the target at 8.7 times trailing EBITDA – that was “a decent discount to the current industry average, which is roughly 10.3 and below a peak reached in 2014,” the news agency wrote two years ago.
When Mr. Buffett purchased BNSF, many investors highlighted the high price he paid to secure some assets that were expected to yield sub-par returns. But then, how about one of its largest deals to date?
In August 2015, Berkshire agreed to acquire Precision Castparts for about $37.2bn, including debt. According to S&P Capital IQ, the deal valued Precision Castparts a bit less than 14 times trailing EBITDA. In those days, Berkshire Hathaway was sitting on a cash pile of almost $70bn, while Mr. Buffett recently talked of a $100bn war chest held by Berkshire on its books in the form of Treasury bills. That is how much GE Aviation is likely worth, by the way, regardless of GE’s current market value.
So, he could actively contribute to a change of ownership at GE – reach out to him if you are interested, and find out if a GE deal, as usual when he is involved, would take just a few weeks rather than months.
Put a 9x-14x EV/EBITDA multiple on a normalized EBITDA of $15bn, and GE’s enterprise value ranges between $135bn and $208bn. So, if we simply deduct $50bn of consolidated net debt at group level, its equity value ranges between $85bn ($9.7 a share) and $158bn (18.1 a share), with a mid-point valuation of $13.9 a share.
I think the low-end estimate of $9.7 a share is way too conservative, for a number of reasons (namely: assets mix, business cycle maturity, liquidation value), and upside could be greater if rather than going with my base-case estimate of $15bn EBITDA annually, we assume GE will hit $17bn this year, and maybe next, which is kind of implied in its free cash flow estimates.
Moreover, the stock currently trades at $14.7, and it would be fair to say that doesn’t price in any M&A premium, which is something worth considering before betting on additional weakness in months ahead, particularly from the second quarter. Yet if you are keen to add it now to a diversified portfolio of assets, you’d be wise to allocate to GE only up to 3% of your total savings, with a stop-loss equal to one year of dividends per share, or $0.48.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.