The math behind GE’s breakup. It’s a feast of the sum of the parts.

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Once the most powerful industrial conglomerate,

General Electric

breaks into three pieces and it’s time to evaluate each of the companies.

This means doing a sum-of-the-parts, or SOTP, evaluation. Wall Street does them from time to time to see if a company’s parts are worth more or less than the whole.

Aviation

GE’s aerospace business, which will be called GE Aerospace, is the most valuable of the companies to be created. It is being described on the streets and by investors as a “crown jewel” industrial asset. Concretely, this means that it is growing steadily and producing above-average profit margins.

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

GE’s aerospace sales grew along with air traffic. In the decade before the pandemic, sales grew at an average annual rate of 6%. Operating profit margins averaged nearly 21% during this period. The average operating profit margin of industrial inventory in the


S&P500

over this period was about 15%. Not bad for a business.

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

Boeing

737 MAX. It’s not bad either.

Barrons compared GE Aerospace to its aerospace peers, including

Saffron

(SAF.France). The comps gave aviation a value of over $80 billion.

Health care

GE Aerospace has been described for Barrons like a big business. GE HealthCare was described as a very good company. Valuations from Wall Street analysts, however, are generally between $35 billion and $45 billion. It looks too low.

Frankly, industry analysts who cover GE don’t seem too interested in GE HealthCare. They will not cover this company. Coverage will be transferred to analysts who cover companies such as

Abbott Laboratories

(ABT) and

Danaher

(HRD).

Sector coverage can influence valuations to some extent. Consider that S&P 500 healthcare equipment companies are trading for around 18 times estimated 2023 earnings. Industrials companies are trading for around 16 times estimated earnings.

There may be fundamental reasons for the deviation, related to cyclicality or profitability. But the gap may also be how 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: the growth of the two companies has been similar over time. Additionally, over the past three fiscal years, GE has generated more operating profits than Healthineers. Barrons used $55 billion worth for GE’s healthcare business.

It seems reasonable. Both companies do similar things: they make a lot of diagnostic equipment. And recurring revenue, which includes things like services and contrast material used in scans, accounts for about 50% of sales.

Power

The energy sector, named GE Vernova, is the most difficult to assess. Profitability is low and the business is still complicated. It will house GE’s gas-fired power business, its renewable energy business as well as GE digital and its network technologies business.

The wind does not bring money to anyone. Over the past 12 months, GE,

Siemens Gamesa Renewable Energy

(SGRE.Spain), and

Vestas wind systems

(VWS.Denmark) lost a total of $2.4 billion.

It doesn’t seem like the wind industry should be that bad. According to the International Energy Agency, wind power generation capacity is growing at double-digit rates every year. Additionally, wind generation is expected to grow at a similar pace for the remainder of this decade.

Growth is good, but inflation, uncertain government policy regarding revolving tax credits as well as the inability to get volume on a product high enough to drive down costs, all conspire to make profits elusive.

Still, the benefits should come one day. If the industry were to earn operating profit margins about half of what aerospace companies earn, a valuation of $14 billion or $18 billion would make sense depending on where an industrial company average negotiates. It’s a way of making an assessment. Barrons used the sale price and valued the business at around 1x sales. S&P industrials are trading for about 1.7 times estimated 2022 sales.

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

There are approximately 7,000 wind turbines in operation worldwide. And they will work for a long time, even if the world completely weans itself from all fossil fuels. Even in a carbon-free world, there is a future for turbine technology. They also burn hydrogen gas.

Yet fear of fossil fuel obsolescence will keep the multiple low on gas power earnings. Barrons valued it at five times the estimated 2023 Ebitda, or about $10 billion.

These are the companies. There are a lot of calculations to do in a SOTP assessment. Adjusting for the balance sheet and duplicating business costs, we arrived at around $125 per share.

Estimates of the sum of the parts, of course, are only approximations. Comparing one valuation to another runs the risk of seeing all valuations go down. They can go up too. After Sen. Joe Manchin (D., W.Va.) and Senate Majority Leader Chuck Schumer (D., NY) reached an agreement that paved the way for climate change legislation, the recovery wind increased to 20%.

By any calculation, GE stock looks attractive to us.

Write to Al Root at [email protected]

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