Going into Earnings, Is General Electric Stock a Buy, a Sell, or Fairly Valued?

General Electric GE stock is up 84% over the last 12 months. Ahead of the company’s third-quarter earnings report, here’s Morningstar’s take on what to look for in GE’s earnings, as well as the outlook for its stock.

Key Morningstar Metrics for General Electric

• Fair Value Estimate: $118.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

GE Earnings Date

Oct. 24, before the market opens.

What to Watch for In General Electric’s Q3 Earnings

• The debate, as implied by the stock price, really centers on the turnaround in renewables. We’ll be watching GE’s progress for how close onshore wind is to breaking even, the mix of North American vs. international projects, and how the grid has progressed on margins. We’d also want to see if there are signs that the Inflation Reduction Act has led to an upshoot in incremental orders.
• We want to see to what extent the fake parts scandal (i.e. AOG Technics falsifying parts documentation) has impacted, or will impact, GE going forward. Up until now, the aerospace debate has been settled.
• Finally, we’d like to see to what extent aerospace supply chain issues have ameliorated, so we’ll be watching book-to-bill ratios (orders divided by revenue) and backlog burn rates (current quarter sales divided by prior quarter backlog).

Fair Value Estimate for GE Stock

With its 3-star rating, we believe General Electric’s stock is fairly valued compared with our long-term fair value estimate.

After updating our model for our aerospace demand forecast, we have lifted our fair value estimate to $118, but that’s due to the time value of money. Our long-term view remains essentially unchanged. We’ve also updated our sum-of-the-parts valuation to $118, suggesting that pricing GE yields a similar conclusion to our discounted cash-flow-derived intrinsic valuation. We still model 2023 adjusted earnings per share expectations of $2.42 (or 12 cents above the high end of management’s revised range) and free cash flow of $4.6 billion, on the high end of guidance.

We value GE at 49 times our 2023 adjusted EPS, but 2023 is a down year from lost healthcare-related earnings. We think the market is looking to 2025 when valuing GE, and we value the firm at 20 times our 2025 adjusted EPS expectations. We think GE Aerospace will trade for about $100 billion in equity value, while GE Vernova will trade for about $30 billion in equity value.

Commercial aerospace remains the most important driver of our valuation. Its fundamentals are still strong. Most of GE’s fleet of narrow bodies have yet to see their first shop visit, and travel remains a continued priority in people’s budgets. Continued evidence of pent-up demand in strong backlog and order strength (1.2 book/bill ratio) gives us continued confidence that GE Aerospace’s revenue will grow at a low 20s percentage in 2023 relative to 2022. We’re content with the lean tools H. Lawrence Culp has implemented as CEO of GE Aerospace. We think a greater focus on discrete business units and streamlined workflows will help the aerospace business continue to expand its operating margins and maintain them at 20% through the cycle, despite the LEAP and 9X ramps, though we expect mix headwinds mean they will be only marginally better than 2022 levels in 2023.

Read more about General Electric’s fair value estimate.

General Electric Historical Price/Fair Value Ratio

Ratios over 1.00 indicate when the stock is overvalued, while ratios below 1.00 mean the stock is undervalued.

Economic Moat Rating

We assign General Electric a narrow economic moat based on its switching costs and intangible assets stemming from its massive installed base of industrial equipment and differentiated technology. We hold off on assigning GE a wide economic moat because of our lack of confidence in its 20-year hurdle rate for excess return on capital.

GE Aerospace meets our highest standard of a wide-moat business and is the company’s crown jewel. The segment benefits from intangible assets and switching costs, and we think it is the premier commercial engine manufacturer that can deliver at scale. Excluding its 50% interest in its CFM joint venture with Safran, we estimate that GE typically commands roughly half of the total commercial engine market, as measured by the installed base. The aviation segment operates on a razor-and-blade model. A GE/CFM engine is present in three out of every four commercial departures.

Relatedly, switching costs are strongly associated with aftermarket sales—the blade in the razor-and-blade model. GE’s switching costs are a result of the firm’s engines and associated equipment’s strong integration into customers’ airframes and landing systems. In the United States, aircraft engine inspections are mandated and regulated by the Federal Aviation Administration, and unplanned downtime related to concerns about an engine’s efficacy can wreak havoc for airlines in terms of time and expense. This high cost of failure ultimately increases customer loyalty. By our count, roughly 69% of GE’s commercial aviation revenue stems from its services, which we believe represents strong evidence of customer reliance on GE as the original equipment manufacturer. Moreover, GE’s rate-per-flight-hour service agreements (whereby original equipment manufacturers like GE receive service payments based on flight hours) both boost returns and solidify switching costs.

After Aerospace, GE’s competitive position fares far worse, with its other businesses facing secular pressure. GE Power faces pricing pressures and a shifting energy mix in its end markets toward renewables. GE Vernova (power with renewables) is a no-moat business.

Read more about General Electric’s moat rating.

Risk and Uncertainty

GE’s principal risk is related to COVID-19 fallout on its commercial aerospace business, including government interventions and acceleration of infections that ultimately affect both revenue passenger kilometers (demand) and load factors (utilization). Additional risks include GE’s significant cash burn amid pricing pressures in some of its operating businesses, including renewable energy, and its insurance liabilities (though they’ve been less of a concern in recent years, given rising interest rates). Finally, GE has a large key-person risk in Culp. Losing him before a successful turnaround would pose critical headline and fundamental risk, in our view.

From an environmental, social, and governance standpoint, we think GE faces a few risks that by now are well-known to investors, including government investigations into its accounting practices, shareholder lawsuits, potential embargoes from defense sales, and the impact of the global energy transition on GE’s gas and steam turbine business (though GE exited its new coal build business and the energy transition mostly helps it with sales of renewables). However, we think the greatest ESG risk relates to fallout from the climate impact from aerospace engines, though we don’t think this is enough to be material, and we point out that GE is developing a next-generation sustainable engine within its CFM Rise program. The firm has also teamed up with NASA to develop hybrid electric engine technology to address climate issues. Given its technology leadership, we expect GE will remain ahead of its competitors, which should ameliorate investor concerns.

Read more about General Electric’s risk and uncertainty.

GE Bulls Say

• Bears vastly underestimate the incremental profits GE will make from operating leverage when commercial aerospace fully recovers and the windfall from the Inflation Reduction Act.
• In our view, GE is led by the premier U.S. multi-industry CEO. Culp has assembled a team of leaders who are steadily changing GE’s culture to one that embraces lean principles.
• GE’s installed base boasts the youngest fleet, with nearly 50% of its CFM fleet yet to make a shop visit. This bodes well for its high-margin aftermarket business.

GE Bears Say

• GE’s turnaround has a lot of unknowns, including when renewables will finally reach profitability and when the Inflation Reduction Act will move toward full implementation.
• While GE will generate orders from the energy transition, it has consistently made negative earnings from both Power and Renewables, and new equipment orders will only pressure and dilute margins further.
• Bulls vastly underestimate the amount of contingent liabilities GE will have to contend with.

This article was compiled by Brendan Donahue.