General Electric (GE) shares hit a 15-month low after receiving a downgrade to sell from hold from Deutsche Bank, which cited a range of issues for the industrial giant, including cash flow pressure to a potential leadership change.
“Overall, we believe GE to be overvalued given weak earnings quality and the wide gap between noncash and cash earnings,” wrote Deutsche Bank analyst John Inch, who cut his price target on the company to 24 from 28.
The core industrial business appears to be struggling, added Inch, who estimates that excluding GE Capital dividends and proceeds from divestitures, “GE does not appear to be generating sufficient cash flow to sustain its operations.”
“We believe GE’s cash challenges are ultimately grounded in GE’s profile as a manufacturer of ‘big iron’ capital goods that require high levels of investment and spending to develop and manufacture,” he wrote.
Inch also said GE’s “weak cash flow has become worse in recent quarters,” noting that it could threaten shareholder returns.
“While GE is going to realize cash inflow from business sales (ie, Water, Industrial Solutions) and ongoing PPE (property, plant and equipment) divestitures, the company appears to be operating relatively ‘close to the line’ in terms of sufficient cash generation to continue to fund such a robust dividend and share repurchase program,” he warned.
Deutsche Bank doesn’t see leadership changing anytime soon — and if CEO Jeffrey Immelt does get the boot, Inch warned that “the next CEO could opt to significantly reset earnings targets lower: possibly closer to actual cash generation.”
“In turn, we expect the market could be negatively surprised by this prospective reset,” he postulated.
Immelt is under scrutiny by Trian Partners’ Nelson Peltz. The activist investor has reportedly been displeased with the GE head’s performance.
Deutsche Bank said GE’s $31 billion in underfunded pension obligations seems high and “could be considered a long term cash call on the company,” adding that the company will contribute $1.8 billion to its pension plan in each of the next two years.
GE’s “inexplicably low” tax rate could actually be a risk, Inch said. If the White House and Congress can manage to revamp the tax code, GE is unlikely to benefit, given that its tax rate is already below what its peers are paying. And if the tax code were simplified and loopholes closed, that could lift GE’s taxes.
GE shares fell as low as 27.85, closing down 2.1% at 28.27 on the stock market today. GE stock has struggled for most of 2017 to retake support at its 50-day and 200-day moving averages.
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