Longleaf Partners Fund, a suite of mutual funds and UCITS funds managed by Southeastern Asset Management, recently released its Q4 investor letter to discuss its quarterly and yearly performance. The letter also included the fund’s stock commentary. Among companies discussed in the letter is General Electric Company (NYSE: GE). Let’s take a look at Longleaf’s comments about the global industrial firm.
General Electric (-54%, -3.14%, -32%, -1.93%), the aviation, healthcare and power company, fell throughout the year, making it the Fund’s largest detractor. GE’s former leadership and business model are dramatically different from what is in place today.
The management team is new, plus the board has been reduced in size and upgraded in quality. The “business” and “price” parts of our investment case boil down to three main assumptions:
1) The best-in-class Aviation and Healthcare businesses continue to deliver strong profit growth, could be severed from the rest of GE and, we believe, are worth a combined $16+/share.
2) GE’s holdings in transportation and industrial services businesses Wabtec and Baker Hughes GE are solid, liquid and have self-help ability to grow earnings. Other smaller businesses like Renewables have demonstrably positive value. This group of assets is worth more than the net industrial debt/share of GE.
3) We believe the currently struggling Power business should recover over several years as the company and the industry right size capacity and headwinds abate. GE Capital’s issues will continue to be addressed aggressively and will be smaller in the 6 years to come. Even a negative value for GE Capital gets to an appraisal for the company that is over 2X the current stock price.
We slowly initiated our position in GE in late 2017 and bought most shares in the first seven months of 2018, after the unexpected increase in reserves for long-term care insurance at GE Capital. Nonetheless, we were too early, with an average cost basis in the low teens. Our adjusted appraisal approaches three times the current stock price, leaving ample margin of safety for a solid return even if some of our investment case assumptions above are wrong. Larry Culp, a legend given his record at Danaher, took the GE CEO job in September after doing deep diligence into the company’s challenges and prospects as a new board member earlier in 2018. GE stock must return to the high teens within four years for half of Culp’s long-term incentive shares to vest and generate the kind of CEO-level pay he could have easily secured elsewhere, and he receives additional shares only if the stock reaches $31 in that period. This degree of out-of-the-money alignment is both extremely rare and highly encouraging.
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Shares of General Electric Company (NYSE: GE) are up 22.86% since the start of this year. The company’s share price fell over 5% after CEO Larry Culp said at a J.P. Morgan conference on Tuesday that GE’s industrial free cash flow “in 2019 will be negative.” The company made $4.5 billion in industrial free cash flow in 2018. “If we’re going from $4.5 billion in 2018 to what I’m framing as negative territory in 2019 … it’s really a combination of operational pressure, power … renewables, and then the non-operational pressures that I’m calling ‘policy,’” Culp was quoted as saying.
In a letter to a letter to shareholders as part of GE’s annual report, Culp said: “We intend to maintain a disciplined financial policy, targeting a sustainable credit rating in the single-A range, GE industrial leverage of less than 2.5x net debt*-to-EBITDA, a GE Capital debt-to-equity ratio of less than 4-to-1, and ultimately a dividend level in line with our peers.”
Under the Culp’s leadership, GE is looking to growth four businesses: Power, renewable energy, aviation, and healthcare, according to the letter.
Meanwhile, General Electric Company (NYSE: GE) is a popular stock among hedge funds tracked by Insider Monkey. Our database shows that 46 funds held GE at the end of the third quarter of 2018. Caspian Capital Partners, Kopernik Global Investors, and Southeastern Asset Management – among others – held bullish positions in the company as of the end of 2018.
Disclosure: none
