Analyst explains ‘the stock’s real appeal’

John Eade, president of Argus Research and director of portfolio strategies, joins Yahoo Finance Live to discuss General Electric earnings and the company’s turnaround.

Video transcript

JULIE HYMAN: Manufacturing giant General Electric and 3M both reported earnings this morning, and the results are being watched closely on the streets. Both companies plan to split some of their business units. 3M just announced today that its healthcare business will be spun off.

Joining us is John Eade, President of Argus Research and Director of Portfolio Strategies. John, thanks for being here. I want to take them one by one because they are quite different situations. So let’s start with General Electric first. And stocks are up today. It seems that people are pretty happy with their results in aerospace. Do you feel, however, before this separation, that General Electric turned a significant corner on you?

JEAN EADE: Not quite, Julie. And I’m a little surprised at the reaction of the market today. Yes, there was a very strong earnings beat. Orders increased by an average figure. Revenue increased by mid-single digits. But cash flow – and I think cash flow is the metric a lot of analysts were looking for – while it turned positive, management downgraded its cash flow forecast for the next 12 months. .

So I thought it would have been a hit for the stock. But I guess people are convinced that the restructuring is coming. And there’s certainly been some nice margin expansion overall, and in the aerospace sector in particular. So check some boxes, but not all of them yet.

Brad Smith: To what extent do you think the supply chain challenges cited by GE may be more of a hindrance to their business than some of the other companies also going through the same supply chain crisis?

JEAN EADE: Oh, that’s definitely a problem. The supply chain adds costs to transportation, raw materials, energy. And then GE has pretty consistent businesses. Like, its healthcare business is pretty consistent. This is the one he will produce first. Aviation is now in good shape, with the 737 Max flying again and commercial jets recovering.

But it’s those power companies where the orders are very lumpy. And so it’s hard to smooth out revenues and align costs. I think they’ve had problems there for five or six years. And these continue in this group, especially with inflation.

BRIAN SOZZI: John, should investors stay away from General Electric? They go through this… they break up the business. You are now seeing costs in the business because of this disruption. You see mixed results across all sectors, which weakens the outlook for free cash flow. Where is the incentive to get involved here?

JEAN EADE: So there are six areas that we look at when analyzing a stock. And you’re right. There’s not a lot of enthusiasm for growth here right now. And financial strength is not the best. But the valuation is quite attractive, in our view. And another factor is the management team. The CEO of GE is the former CEO of Danaher, as everyone knows. And Danaher is a long-time success story, especially in terms of generating free cash flow.

So there is still confidence that CEO Culp can lead and accomplish this turnaround at GE. And I think that’s the real appeal of the stock, you know, what it can do, as opposed to how these companies grow or improve.

Brad Smith: And Culp has drawn criticism in the past for his salary packages. So he has many roles that he took over at GE. And so, with all of that in mind and so much talk of layoffs or hiring freezes across all industries right now, do you think GE is able to sustain its workforce? Are they going to have to cut even more from here, even amid some of the restructuring they’re implementing?

JEAN EADE: Well, we’ve seen the overall operating profit margin go from something like 6% to 9%, or about 300 basis points. In a time of high inflation, really, the best way to do that is to cut your hiring or even start laying off.

But even at 9%, GE’s margins are way, way below, say, 3M, which is around 20%, or Roper, which is around 30%. And the way to do that is to increase revenue, but in a slow growth environment, there’s probably some workforce attrition that we’ll see at GE, I guess, over the next two years.

BRIAN SOZZI: John Eade, President of Argus Research and Director of Portfolio Strategies, always nice to see you. Goodbye.

JEAN EADE: Thanks.

Keith P. Plain