Near the end of 2021, General Electric Co. (GE, Financial) announced its bold plan to separate into three different businesses, spinning off its health care and energy segments and leaving the core business focused on aviation.
With the spinoff of GE HealthCare Technologies Inc. (GEHC, Financial) completed on Jan. 4, the company hopes to leave its years of downsizing and decline behind it and begin a new era focused on three markets with solid growth prospects.
Despite worries that the deteriorating economy could cause issues, so far the health care spinoff has demonstrated that GE’s split-up is working wonders. Investors have bid the new company up to a price-earnings ratio of 58.58, and even though the separation of the energy business has been delayed until 2024 due to ongoing profitability issues, investors still bid GE’s stock up more than 6% on Thursday on the news the company expects the prospering aviation segment to make up for the losses.
With the resounding success of the health care spinoff, can investors expect a similar story when GE eventually separates its energy business? Just how much is the energy business still keeping the aviation segment’s multiples depressed?
Tech leadership and pent-up demand
GE HealthCare’s stock is performing well post-spinoff, which is due in large part to its tech leadership in medical imaging and the pent-up demand for scans and procedures that were delayed due to Covid-19.
With the tailwind of the aging population in the U.S., there will likely be sustained demand growth in the years to come, especially as new technologies are developed that improve health outcomes and (hopefully) reverse the trend of declining life expectancy. According to estimates from Fortune Business Insights, the global medical imaging market is expected to grow at a compound annual rate of 5.8% through 2028, and this market is where approximately half of GE HealthCare’s revenue comes from.
GE HealthCare recently reported its first earnings results as an independent company, detailing its fourth-quarter and full-year 2022. Revenue for the quarter grew 8% year over year, which is higher than the medical imaging industry’s overall growth rate, driven not only by end market demand but also by pricing increases and easing supply chain pressure.
“Looking ahead, we're confident that our accelerated investment in innovation, as well as standardization across platforms, will drive revenue and margin growth. We're seeing customers continue to invest along with macroeconomic tailwinds, such as increasing healthcare digitization, expanding access to care, and an aging population globally,” CEO Peter Arduini said.
A booming aviation market
Moving on to the remaining GE businesses, the aviation business has performed well as travel rates recover and new planes enter service. In fact, better-than-expected aviation results are expected to make up for worse-than-expected renewable energy results, with GE holding its 2023 earnings per share estimates steady at $1.60 to $2.00.
GE’s aviation business is a key component of global commercial air travel as it makes and services commercial aircraft engines for both Boeing (BA, Financial) and Airbus (XPAR:AIR, Financial). GE estimates this segment should generate double-digit revenue growth in 2023, translating to operating profit of $5.3 billion to $5.7 billion, though overall this will be dragged down to the high single digits by lower growth from the energy businesses.
One major tailwind for the aviation business is the need to reduce fossil fuel consumption with more efficient engines in the near term and alternate fuel sources in the long term. This should help ensure that the latest engine technology is always in demand.
The company’s joint venture with Safran SA (XPAR:SAF), CFM International, is even working on an aircraft fueled by hydrogen. Whether hydrogen energy is renewable or not depends on how it is produced, but if electrolysis is fueled by a renewable energy source like wind or solar, it could power pollution-free flights.
Can the energy segment stand on its own?
Given the precedent set by the health care spinoff, it seems likely that the energy segment spinoff, when it happens, will boost the aviation segment’s valuation. However, can GE’s struggling energy segment stand on its own someday?
According to GE’s latest estimates, the energy business, now called GE Verona, is expected to record an operating loss between $200 million and $600 million in full-year 2023. The company blames the continued lack of profitability on weak demand, higher costs and supply chain disruptions in its renewable energy segment.
GE reiterated on Thursday that it is transforming its renewable energy business and still expects profitable growth in the long run, though in the near term, the offshore wind unit in particular is facing challenges. Some analysts, such as William Blair's Nicholas Heymann, are wondering if there is a chance GE Verona will not include the wind energy unit at all, as eschewing this segment would increase its chances of turning a profit soon.
There are three main problems with the wind energy unit. The first is the unreliability of older turbines, which sometimes have downtime and result in having to make warranty payments to customers. The second is manufacturing inefficiency due to the many different turbine models. The third is that it has been barred from selling its Haliade-X wind turbines in the U.S. after a jury found it guilty of infringing on a competitor’s patent.
GE can solve two of these problems by creating a smaller number of more efficient turbines that do not infringe on anyone else’s patent rights, but retiring the older inefficient models will likely be a drag on finances for years to come.
Valuation and takeaway
With a forward price-earnings ratio of 46.77, GE is not trading cheap, though if it can meet guidance for 2023, it will still be cheaper than its health care spinoff. According to estimates from Morningstar (MORN, Financial), GE could bring in earnings per share of $4.78 in 2025, but those same analysts are also projecting 2023 earnings per share of $2.58, which is lower than GE’s own estimates.
Assuming the company can double its own 2023 earnings estimates by the time 2025 rolls around, it would still be undervalued at current levels, especially when we consider that after the energy segment spinoff, what is left behind will be the much stronger aviation business.
Fortunately, the energy business does not need to be profitable immediately upon spinoff, as proven by the plethora of other companies on the market that still remain in operation despite burning cash year after year. It is possible the company may cave to pressures for near-term profitability and divest the offshore wind unit, but GE has not yet brought up that topic.