Can a sleeping industrial giant wake up and make some positive noise about its core operations? It’s possible. General Electric (NYSE:GE) is in transition mode, leaving behind its lackluster performance to become a stronger and healthier company. As it gains momentum, what should investors know about GE stock?
The stock has nearly doubled in the past year as GE made several moves to strengthen and focus the company. It completed a reverse stock split and saw strong earnings in the second quarter of 2021. However, General Electric isn’t in the clear yet — it still faces several risks that could disrupt its recovery.
A Reverse GE Stock Split and an Earnings Beat
In late July 2021, General Electric completed a 1-for-8 reverse stock split. The process decreased the numbers of shares and increased its stock price, but overall did not change anything about the company’s fundamentals.
The split may have had a psychological impact for some investors, as the resulting change in the GE stock price was large. But for informed and educated investors, it was just a technical adjustment to the stock price and the total number of shares outstanding. It did not make GE stock any more valuable than it was before the split.
The big and important news for GE stock was that the company beat earnings estimates for Q2 2021. Additionally, it reported a positive cash flow and increased its cash flow guidance for fiscal year 2021. All of this is positive news that would move any stock upward. Investor’s Business Daily reported the following:
“Estimates: Wall Street expected GE to swing to EPS of 3 cents from a loss of 15 cents per share a year ago. Revenue was seen growing 2% to $18.14 billion, according to FactSet. In addition, analysts forecast a Q2 cash burn of $338.3 million.
Results: GE earnings came in 5 cents a share as revenue grew 8.9% to $18.3 billion. Industrial cash flow came in a positive $400 million vs. year-ago cash burn of $2.068 billion.”
General Electric operates in four core segments: aviation, healthcare, renewable energy and power. Most of these operations saw growth in Q2.
The company seems optimistic about its free cash flow in 2021. It increased its industrial free cash flow estimate for the year to $3.5 billion to $5 billion. It previously expected $2.5 billion to $4.5 billion.
Risks Remain for GE Stock
An article on CNBC stated GE is worried about inflationary pressures in 2021. CEO Larry Culp said the company is using price increases, different raw material sourcing methods, reduced waste and higher productivity to counter potential inflation.
In an interview with Reuters, Culp noted, “We’re certainly not immune from these inflationary pressures. We’re going to see more of that pressure in the second half.”
In general, a company facing inflationary pressures has two choices. One option is to pass the extra costs on to customers by increasing prices and possibly losing sales to cheaper competitors. Alternatively, the company can absorb the extra cost and potentially hurt its profitability.
Which route will General Electric take? We do not know yet, but a significant restructuring effort is already underway.
GE’s Balance Sheet Needs Improvement
The company has decided to improve its balance sheet and reduce its debt level. This is a wise move, as GE’s performance over the past five years has been far from rosy.
Take, for example, the current Altman Z-Score on Gurufocus. It is 1.4, suggesting General Electric is in a distress zone. Additionally, GE has a current debt-to-equity ratio of 1.9.
Two of the weakest financial metrics GE has are its profitability and its revenue growth. It has a negative three-year growth rate. In 2016, General Electric reported revenue of $119.87 billion. In 2020, it saw revenue of $79.89 billion — a decline of nearly 16% compared to 2019.
At the same time, its gross income has been declining. Operating income, or EBIT after unusual expense, has been weak and negative from 2017 to 2020. Additionally, its profitability is highly volatile.
GE’s 2020 net income of $5.67 billion was an increase of more than 1,200% compared to 2019. That is promising, but I do not believe this spike in revenue growth is easily sustainable.
Finally, its free cash flow is also highly volatile. Although it turned positive both in 2019 and in 2020, MarketWatch reports there was a decline of 88% to $345 million in 2020 from $2.96 billion in 2019.
Wait Until It Recovers More Before Buying GE Stock
The last time General Electric repurchased any stock was in 2018. This, combined with its financials, indicates the company has a long way to go before it is out of the woods.
To conclude, I believe GE stock is in a critical stage. It is showing improvement as per the latest earnings report, but underlying risks are still high.
Investors should be patient and wait to evaluate next quarters’ results before making any moves. I would not jump in and start buying GE stock until there is further improvement on the company’s balance sheet. I want to see this slow financial recovery become sustainable, and hopefully even grow stronger and pick up the pace in time.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.