Why we're expecting a four-bagger from this U.S. blue chip stock

Benj Gallander, Ben Stadelmann, and Philip MacKellar
October 12, 2022

Numbers can be deceiving. If one chooses to look at the acquisition price of General Electric Co. GE-N by Contra in 2010 of US$15.56 and compare it with the sticker today around US$65, it sure looks sexy. Alas, that is before the one-to-eight stock consolidation last year, making the equivalent cost US$124.48. A hold of a dozen years to lose almost half of the investment is the very definition of unsexy. The quarterly dividends throughout this period helped salve the wound a bit, but really, not much. Ultimately, this has simply been a dreadful investment.

When it was purchased, Benj shunted aside one of his regular guidelines by buying a stock over $10. The logic behind this is that it is easier for a stock to go from, say, $5 to $25, than from $50 to $250. Benj has been successful other times when he defied the general tenet, such as when he bought Yahoo! at US$11.11 and finished selling less than six years later at US$41.24. Unfortunately, lightning did not strike twice.

Often immediately after a reverse stock split the price has a quick jump before it proceeds to slide – or tumble – over the next year. The plan here was to capture this upside, but it did not work out.

GE has undergone a massive revamping over the past dozen years. Revenues are less than half of what they were, now sitting at around US$74-billion annually, with a primary reason being that many divisions have been sold. The debt load is about one-tenth of what it was, currently around US$35-billion. Moreover, the outfit loses money more often than not and the erratic earnings are unlikely to change in the near future.

Most of the substantial changes have come under the watch of chairman and chief executive Larry Culp, who was hired four years ago. He had a sterling track record, leading the transformation of Danaher Corp. DHR-N from 2001 to 2014. He was the first outsider to lead the enterprise when he joined GE, and his goal was to focus the company on its strengths and cut the distractions. This he has clearly done, but undoubtedly the job is not nearly finished, and it faces major headwinds.

Sticky supply chains, which are negatively affecting cash flow, a lack of raw materials and inflationary pressures are at the forefront of the problems. The company suspended operations in Russia, but fortunately that accounted for less than 2 per cent of sales. That said, much of the titanium metal needed in aerospace for landing gear, blades and turbine discs comes from Russia, the third-largest producer of the commodity, after China and Japan, respectively. Looks like GE will have to shop elsewhere to fulfill its needs.

Additional major changes are now afoot. The organization is on a firm trajectory to split into three and this is a primary reason for our optimism. Normally, when a company subdivides, the stock price of the component parts do better than if the entity had remained as one. In the case of GE, the health care component is expected to go early in 2023. The plan is to combine and then spin out the power and renewable energy units in 2024. The remainder will be an aviation-focused firm.

Mr. Culp has a fat pay package; his current salary works out to more than US$20-million annually. Additional bonuses of his agreement entail that if the stock price increases by 50 per cent, his pay package could go up by US$47-million; for a 150-per-cent increase, his total pay would rise by around US$300-million. At this point, that money is just a dream. Hopefully, his future pay will be reduced commensurate with a far smaller GE. He does seem bullish on this outfit, having purchased US$4.8-million worth at an average of US$75.26 a share over the past year.

A decade ago, GE had more than 1.3 billion shares outstanding, split adjusted. Now it is slightly less than 1.1 billion and a buyback continues. The book value is slightly less than half the trading price.

Over the years, Benj has given lots of thought into taking a tax loss on this one and writing it off against our sturdy gains. That would have been an excellent idea as less money would have been paid to the tax authorities – money that could have been reinvested. But that was never done and with the corporate split getting closer, it seems worthwhile to wait. Yes, patience is wonderful, though it is not always rewarded.

In 2007, GE traded at a preconsolidation equivalent above US$300. At the end of 2015, GE’s stock price was better than US$240. While we are not predicting those rarefied heights in the near future, we believe that the combined tally of the divided company could reach the latter level once again. That would mean about a four-bagger from the current level around US$65, something that our contrarian methodology of buying beaten-down stocks often produces. Of course, given our lack of success here over the past dozen years, perhaps anything suggested should be taken with a grain of skepticism. Or a bucketful.