Morningstar - Q3 2021 - 71

Nice Comeback
GE is one of our top picks in the industrial sector.
Joshua Aguilar
BEST IDEAS: EQUITY
This article is adapted from a Morningstar equity research report dated
July 2, 2021.
General Electric GE is undergoing a transformation under CEO Larry Culp
that the market has yet to fully appreciate. GE's aviation segment, in our view,
is the premier commercial engine manufacturer in the world at scale.
We believe there is significant pent-up demand for air travel, which gives us
confidence that aviation sales can recover to 2019 levels by 2023. According
to the International Air Transport Association, in some developed markets,
consumers' excess savings now exceed 10% of GDP. Indeed, domestic
air travel is already showing signs of a significant recovery in some geographic
markets. In the United States, domestic summer bookings are close to
prepandemic levels, while airport security checkpoint figures reveal that
passenger throughput is rapidly approaching 2019 levels.
From this standpoint, GE is well positioned, given its industry-leading installed
base of equipment in its narrow-body engine duopoly with Pratt & Whitney.
While margins will face some mix headwinds in the near term given demand
for equipment, over the long term, over 60% of GE's 37,000 total installed
engines have yet to see a second shop visit. Further, given the segment's high
fixed-cost structure, a high degree of operating leverage should buoy its
incremental margins in the aerospace recovery, which we believe will readily
exceed the 50%-plus decremental margins experienced during the downturn.
GE is also a global leader in precision health. We expect the healthcare
segment will continue its steady march of operating margin expansion of 25
to 75 basis points through additional digital mix and cost productivity
initiatives. We also think healthcare will grow its top line on the lower end of
midsingle digits, primarily through organic investments in mission-critical
applications like oncology, while supplementing these endeavors with
strategic bolt-on acquisitions. These investments further capitalize on many of
the secular trends benefiting the industry, including an aging population,
greater access to care, and a growing shortage of physicians who can meet
these needs.
At the forefront of remaining catalysts is the pending merger of AerCap with
Gecas, GE's aircraft leasing business, which should allow GE to refocus on
its industrial operating segments and simplify its reporting structure while still
retaining an interest in the combined entity in the commercial aerospace
General Electric GE
Stats 06/30/2021
Morningstar Rating
QQQQ
Price
$13.46
Economic Moat
Narrow
Price/Fair Value 06/30/2021
$20
Fair Value Estimate Per Share
15.70
13.46
10/2018
Month-End Closing Price
10/2019
10
15
5
10/2020 06/2021
Sector
p Industrials
Fair Value Estimate
$15.70
Capital Allocation
Exemplary
Industry
Splty Indstrl Machinery
Uncertainty
High
Market Cap
$118.2 Billion
recovery. Second, rising interest rates reduce GE's pension obligation,
with every 25 basis points creating a $2.4 billion tailwind, prior to the effect
of hedges. Third, GE will spend significantly less on restructuring, legal,
and pensions.
Fourth, GE could reraise its full-year 2021 industrial free cash flow guidance
of $2.5 billion to $4.5 billion to the high end of its guidance, in line with
our current thinking. We point out the current guidance includes the
discontinued factoring impact of about $800 million in the first quarter. In our
view, this represented a de facto raise in the full-year free cash flow guidance
first announced at GE's outlook meeting in March because it lowered the
adjustment due to factoring headwinds. Finally, GE has good options with
potential deals to either ringfence its insurance liabilities, or monetize its
healthcare segment through an IPO or similar transaction. K
Joshua Aguilar is an equity analyst with Morningstar Research Services LLC.
morningstar.com/lp/magazine
71
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Morningstar - Q3 2021

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