Gordon Haskett: General Electric Bull Thesis 'Dubious And Lacking Basic Intuition'

As General Electric Company GE prepares to provide a critical financial update for its shareholders on Thursday, investors are still trying to figure out exactly how a blue chip company worth $300 billion at the beginning of 2016 could now have a market cap of under $90 billion.

According to the Wall Street Journal, nefarious accounting practices were responsible for the disconnect between GE’s reported value and its market cap, and one analyst says Wall Street expectations for GE’s future may still be too high.

How GE Fooled Wall Street

WSJ's Michael Rapoport focuses on GE’s accounting treatment of a $10 billion 2015 deal with Alstom SA ALSMY as one example of the dubious way GE was propping up its bottom line right under investors’ noses.

GE acquired Alstom’s Power business for $10 billion but then immediately registered $13.5 billion in goodwill on its books upon the deal’s completion. In the accounting world, goodwill is the amount of money a company spends on an acquisition that is above and beyond the asset value of the target. While this practice wasn’t strictly illegal, it essentially allowed GE to claim Alstom’s Power business, which GE purchased for $10 billion, had a net negative value of $3.5 billion.

Incredibly, Rapoport wrote, the strange treatment of the Alstom deal didn’t stop there when GE ramped up the goodwill associated with the deal to $17.3 billion in 2016.

Why would GE perform such seemingly strange accounting maneuvers? The general idea is that GE was likely attempting to avoid depreciation and/or amortization costs associated with the Alstom assets, which would have eaten into GE’s profits in each quarter since the deal’s completion. By reducing the value of the Alstom assets on its balance sheet, GE was simply carrying the Alstom assets as goodwill quarter-after-quarter, avoiding taking the inevitable earnings hit that was building under the surface.

Ultimately, GE took a $22 billion goodwill writedown in late 2018 and many investors and analysts were completely blindsided as to where the charge came from and why it was so large.

Expectations Still Too High

Unfortunately for GE investors, Gordon Haskett analyst John Inch said Wednesday analysts expecting GE to eventually recover from its current batch of problems may have their sights set too high.

GE recently guided for negative free cash flow from its Industrial segment in 2019. Some analysts have said the cash flow problems are only temporary, and GE will ultimately get back to $1 per share in free cash flow in the next couple of years.

“Considering GE’s divestitures of high cash generating businesses coupled with Power’s substantial long-term challenges, this aspirational target screens as both dubious and lacking basic intuition,” Inch wrote in a note.

Inch said GE would essentially need to double its EPS over the next three years to get to $1 in free cash flow by fiscal 2021, an outlook that doesn’t make much sense considering GE’s plan is to sell off some of its best-performing assets in the meantime to shore up its balance sheet. Inch also said he believes GE’s Aviation business is currently approaching a cyclical peak.

Inch is calling for 35 cents per share in free cash flow from GE in fiscal 2020 and only modest growth from that point forward.

Gordon Haskett has an Underperform rating and $7 price target for GE's stock.

Shares traded at $9.98 Wednesday afternoon.

Related Links:

GE CEO Says Industrial Free Cash Flow Will Turn Negative In 2019

Analysts Remain Skeptical Amid General Electric's Aggressive Asset Sales

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