What Will It Take for Belief in GE's Comeback?

Despite severe aerospace coronavirus-related headwinds, narrow-moat General Electric, or GE, surpassed our expectations year to date on its top line, earnings per share, and industrial free cash flow. Therefore, we raise our fair value estimate by over 8% to $10.40 from $9.60 previously. Our new fair value estimate puts us the very top of CapIQ consensus estimates in fundamentals and near the top of price targets (which is affected downward by the normalized weighted average cost of capital in our model).

While there were various puts and takes in our model, the primary driver in our increased optimism was healthcare’s outperformance--it knocked the cover off the ball. Segment operating margins improved sequentially by 270 basis points and 260 basis points year over year on an organic basis (when stripping out the effect of the sale of biopharma to Danaher). This is a business we originally expected to grow about 50 basis points after the sale to about 15.2% for full-year 2020. We’re now expecting healthcare segment operating margins in 2020 of about 16.8%, though we note one quarter bakes in the biopharma as the sale occurred during the first quarter of 2020.

Our confidence stems further from GE CEO Larry Culp’s public commentary that he believes the healthcare team can expand 75 basis points year over year, while performing at low-single-digits plus at the top line (at the midpoint). While these figures are nothing new per se as they were shared during the December GE Healthcare Investor Day, the team has outperformed expectations. What was interesting was Culp’s willingness to quote the top end of the range for margin expansion. In our experience, Culp is not prone to wild prognostications, and we’re confident in his leadership.

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