The Math Behind GE’s Breakup. It’s a Sum-of-the-Parts Party.

Aviation

GE’s aviation business, which will be called GE Aerospace, is the most valuable of the businesses to be spun out. It gets described on the Street, and by investors, as a “crown jewel” industrial asset. Practically speaking, that means it grows consistently and produces above average profit margins.

Growth is easy to understand. The number of people on planes has grown about 5% a year on average for generations, according to the International Air Transport Association. Covid-19, of course, hurt that growth rate over the past couple of years. But things should normalize. People like to travel.

GE’s aviation sales have grown in line with air traffic. In the decade before the pandemic, sales grew at a 6% average annual rate. Operating profit margins averaged almost 21% over that span. The average operating profit margin for industrial stocks in the

S&P 500
over that time frame was about 15%. Not bad for a business.

Being a crown jewel isn’t all about profits though. It is also about market position. GE has roughly 75% market share in jet engines powering single-aisle jets like a

Boeing

737 MAX. That isn’t bad either.

Barron’s compared GE Aerospace to aerospace peers including

Safran

(SAF.France). The comps made aviation look worth more than $80 billion.

Healthcare  

GE Aerospace was described to Barron’s as a great business. GE HealthCare was described as a very good business. The valuations of Wall Street analysts, however, are typically in the $35 billion to $45 billion range. That looks too low.

Frankly, the industrial analysts that cover GE don’t seem overly interested in GE HealthCare. They won’t cover that company. Coverage will transfer to analysts that cover companies such as

Abbott Laboratories

(ABT) and

Danaher

(DHR).

Industry coverage can influence valuations to some extent. Consider that healthcare equipment companies in the S&P 500 trade for about 18 times estimated 2023 earnings. Industrial companies trade for closer to 16 times estimated earnings. 

There might be fundamental reasons for the gap, related to cyclicality or profitability. But the gap can also be the way analysts and investors are used to treating different industries.

At $45 billion, GE would be worth about 60% of

Siemens Healthineers

(SHL.Germany). Here’s the thing: Growth for both businesses has been similar over time. What’s more, over the past three fiscal years, GE has generated more operating profit than Healthineers. Barron’s used a $55 billion value for GE’s healthcare business.

It seems reasonable. Both firms do similar things: They make a lot of diagnostic equipment. And recurring revenue—which includes things such as services and contrast medium used in scans—is in the range of 50% of sales.

Power 

The power business, named GE Vernova, is the tough one to value. Profitability is low and the business is still complicated. It will house GE’s gas power business, its renewables business along with GE digital, and its grid technologies business.

Wind doesn’t make money—for anyone. Over the past 12 months, GE,

Siemens Gamesa Renewable Energy

(SGRE.Spain), and

Vestas Wind Systems

(VWS.Denmark) have lost a combined $2.4 billion.

It doesn’t feel like the wind business should be that bad. Wind power generating capacity is growing at double digit rates annually, according to the International Energy Agency. What’s more, wind generation is expected to grow at a similar rate for the rest of this decade.

Growth is good, but inflation, uncertain government policy about renewable tax credits as well an inability to get volume on any one product high enough to drive down costs all conspires to make profits elusive.

Still, profits should come some day. If the industry were to earn operating profit margins of roughly half of what the aviation businesses earns, a valuation of $14 billion or $18 billion would make sense based on where an average industrial business trades. That is one way to do a valuation. Barron’s used price to sale and valued the business at roughly 1 times sales. Industrial businesses in the S&P trade for about 1.7 times estimated 2022 sales.

The other big part of Vernova, GE’s gas turbine business, is profitable. It has made almost $900 million in operating profit over the past year.

There are about 7,000 turbines operating around the world. And they will be operating for a long time—even if the world completely weans itself off all fossil fuel. Even in a zero carbon world there is a future for turbine tech. They burn hydrogen gas too.

Still, the fear of fossil fuel obsolescence will keep the multiple low on gas power profits. Barron’s valued it at five times estimated 2023 Ebitda, or about $10 billion.

Those are the businesses. There is a lot of math to do in a SOTP valuation. Making adjustments for the balance sheet and duplication of corporate costs, we arrived at about $125 a share.

Sum-of-the-parts valuations, of course, are just approximations. Comparing one valuation to another runs the risk of all valuations coming down. They can go up too. After Sen. Joe Manchin (D., W.Va.) and Senate Majority Leader Chuck Schumer (D., N.Y.) struck a deal that paved the way for climate change legislation to move ahead, wind valuation shot up as much as 20%.

Whatever the math used, GE stock looks attractive to us.

Write to Al Root at [email protected]