The GuruFocus Value calculator has a warning about General Electric Co. (GE, Financial)—it could be a value trap! That's a stock that looks like a bargain, but is cheap because the company is in serious trouble and might even go bankrupt. As you can see in the chart below, the price has dropped dramatically in recent years:
Yet, the stock enjoys the confidence of 21 gurus, and the three biggest holders of General Electric actually increased their holdings in the second quarter of 2020.
What are we to make of these conflicting messages? Is this price an opportunity to buy a good stock at a beaten-down price, or is it a money pit?
On the value-trap side of the scale, we see a valuation that has plunged over the past four years. In July 2016 the share price closed at $31.19. Two years and two months later it is down to $6.13. Shareholders who owned and kept the stock have suffered serious capital losses.
Investors might expect that the plunge would drive up the dividend yield, but in late 2018, General Electric cut its dividend from $0.12 to $0.01 per quarter. That saved the company $3.9 billion per year, which was good, but its financial strength is still bleak:
It's a table with a lot of bad news, starting with debt issues on the first five lines. As we can see, interest coverage is low, the Altman Z-Score is in the distress zone and the company has been paying more for its capital than it is generating in earnings.
However, there is some good news about the debt - it seems to be decreasing:
Getting back to the bearish side of GE's financials, we turn to discouraging data on the profitability table:
Note that the operating margin compares unfavorably with its competitors and peers in the Industrial Products industry, as well as with its own history. The net margin is negative, as are the return on assets (ROA), return on equity (ROE), revenue growth and Ebitda growth.
Because of the dividend rate cut last year, the dividend table does not offer much encouragement:
Despite all this bad news, a significant number of the investing gurus followed by GuruFocus had positions in General Electric at the end of the second quarter.
The largest was that of HOTCHKIS & WILEY, which owned 135,847,498 shares for a 1.55% stake in General Electric. The firm increased its ownership by 34.36% during the quarter. Richard Pzena (Trades, Portfolio) of Pzena Investment Management added 16.11% to his holding and finished the quarter with 74,973,028 shares, while the T Rowe Price Equity Income Fund (Trades, Portfolio) increased its holding by 9.57% to 41,775,000 shares.
Why were the gurus adding to their positions? It could be because of the turnaround initiatives underway. In March of this year, fellow GuruFocus contributor Nicola Guida outlined the many measures that the new CEO, Larry Culp, is spearheading:
- Selling the biopharma unit for $21.4 billion to Danaher Corp. (DHR, Financial).
- Spinning off the transportation division and merging it with Wabtec Corporation (WAB, Financial), bringing in $2.9 billion.
- Selling PK AirFinance for an estimated $3.6 billion.
- Selling a portion of its stake in Baker Hughes (BHGE, Financial) for some $3.0 billion.
- Making changes to its pension plans that reduced its pension deficit by $5 billion to $8 billion
As a result of these and other measures, General Electric so far has been able to get through the Covid-19 economic slowdown that began in March.
In the second-quarter results, the company announced it had $41 billion in cash, including $20 billion from a credit facility (i.e. additional debt). In addition, it cut its near-term liquidity needs by $10.5 billion and had reduced its debt by some $9.1 billion in the first half of this year (and by about $22 billion since the beginning of 2019).
As a result of these initiatives, GE is now in better financial shape and is more focused.
Moving forward, the company is focused on three strategic priorities: improving its financial position, strengthening its businesses and driving long-term profitable growth.
General Electric's finances obviously have taken a turn for the better with asset sales and reductions in debt. While the pandemic has dented its plans for this year, it has made substantial progress and could become profitable for those who wait.
In strengthening the business, General Electric now has a CEO with experience in lean management. Culp wrote in the 2019 Annual Report:
"The best tool I know to drive this type of positive change at a fundamental level is lean management, in which a relentless focus on customer value helps leaders get to the root cause of problems, continuously eliminate waste, and ruthlessly prioritize their work."
Before moving to General Electric in 2018, Culp worked for Danaher, a company that grew rapidly by purchasing troubled companies and then turning them around using lean management. He gave these examples of improvements made at General Electric last year:
"our Digital team uses lean to shorten the time it takes for our customers to install or update our software while also creating software for customers to map and eliminate waste in their own processes. This is resulting in significantly quicker turns; for example, we reduced planned downtime on a software upgrade for one major manufacturer by 50 percent."
Such improvements are the stuff of long-term profitable growth, both by increasing value to customers and reducing waste and costs. It will also help that General Electric's management can focus on fewer businesses.
Conclusion
Investors will have to decide whether the General Electric glass is half empty or half full. The bear case would begin with the company's dismal financial and profitability results over the past decade and point out that while there may have been recent improvements, the company is not yet a compelling opportunity by any current measure. It may indeed be a value trap.
Bulls will deemphasize the past and point to the forward strides made since Culp took the helm in 2018. They will also note how well the company might do once it regains its financial and operational footing. I suspect many gurus who own General Electric are in this camp.
Income investors will spend no time on the company because it has cut its dividend to practically nothing. Value investors might see an opening here if they can live with General Electric's smaller debt load. Growth investors will likely watch and wait to see if the share price starts moving up again.
Disclosure: I do not own shares in any of the companies named in this article.
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