General Electric stock: set up for a lower valuation (NYSE: GE)

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General Electric (NYSE:GE) faces an uncertain future, which is reflected in the company’s valuation.

The industrial company faces a variety of challenges, including rising raw material costs, supply chain issues, a highly cyclical aerospace division and increasingly volatile free cash flow forecasts.

With General Electric’s earnings date approaching next week (October 25, 2022), investors may wish to avoid the industrial giant until it charts a clear course for its free cash flow in 2022 and 2023.

3T-22 earnings likely impacted by rising costs and supply chain issues

The market expects General Electric to earn $0.47 per share and generate $18.81 billion in revenue in the third quarter.

With growing uncertainty in its industries, I think General Electric will have to report dismal results.

Rising raw material costs and ongoing supply chain issues likely weighed on General Electric’s third-quarter operations, possibly leading to a disappointing earnings report next week.

Earnings

Profit (General Electric)

The Aerospace segment is currently the best performer for General Electric, benefiting from strong growth in orders for equipment and services. The segment’s revenue grew 27% to $6.1 billion in 2Q-22, but it could face significant challenges in the near future as the US economy appears to be in decline.

The problem with aerospace is that it is a highly cyclical industry, and the recent surge in orders for equipment and services from General Electric was most likely driven by pent-up demand in the wake of the pandemic. . In short, as the economic outlook deteriorates, aerospace is particularly vulnerable to a severe drop in profits.

Revenue increase

Revenue Growth (General Electric)

Free cash flow is likely more at risk than at any time last year

Given the recent economic uncertainty, I think the industrial giant will struggle to meet its free cash flow guidance next week.

General Electric previously forecast free cash flow of $5.5 billion to $6.5 billion this year, but said in the latest earnings release that $1.0 billion of that free cash flow will be deferred to the next year. following year due to the “working capital dynamics calendar”.

I have a hard time imagining that General Electric will meet its reduced free cash flow target given that free cash flow was only $162 million in the second quarter and minus $718 million in the six months ending in June.

Free cash flow

Free cash flow (General Electric)

To achieve its free cash flow estimate for 2022, General Electric will absolutely have to kill it at 3Q-22 and 4Q-22, the odds of which have dropped significantly in my opinion, given that the US economy is obviously slowing and the inflation continues to wreak havoc on businesses and consumers.

Moreover, when the outlook for economic development deteriorates and uncertainty grips business decision-making, businesses have a strong propensity to postpone capital investment and equipment upgrades.

As a result, investors should expect General Electric’s third-quarter earnings to fall below estimates and the industrial giant to defer free cash flow further into the year ahead.

General Electric stock is valued at 15-17x free cash flow, based on $4.5 billion to $5.5 billion of free cash flow this year, which can be considered a stretched multiple given the industrial conglomerate’s profitability issues, particularly in the Power and Renewable Energy divisions.

General Electric’s healthcare business provides some security for investors because consumers want GE’s healthcare products even during recessions, which can help stabilize revenue growth and free cash flow.

Health pole

Health Division (General Electric)

Why General Electric might see a higher valuation

If General Electric does not lower its free cash flow forecast for 2022 and instead reports robust growth in orders and sales in the Aerospace division, I could be wrong about General Electric and investors could return to the company.

The manufacturer also announced that it will proceed next year with the split of its health division, which could serve as a growth accelerator.

That said, I still believe that the risks outweigh the possible returns here, since General Electric will remain dependent on cyclical aerospace activity for the foreseeable future, and estimating free cash flow seems increasingly unattainable. , given cost and supply chain challenges. .

My conclusion

Only buy General Electric shares when the industrialist has clarified its free cash flow condition.

I think that the manufacturer should revise downwards its free cash flow forecast at the end of the month, which will weigh heavily on investor confidence. Also, buying a highly exposed cyclical conglomerate at the onset of a recession may not be a sound financial decision.

The dangers of a recession are particularly acute in General Electric’s aviation division, which has been the company’s growth engine in recent quarters. Keep your distance.

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