Investment banking giant Morgan Stanley initiated coverage of General Electric (GE) stock Wednesday. According to 4-star analyst Joshua Pokrzywinski, the $8.80 stock should be worth about $10 within a year — a near-14% potential profit that would outdo the S&P 500’s performance in most years. And yet, despite the profit potential, Pokrzywinski can’t quite see his way clear to actually recommending “buying” GE stock, assigning the shares only an “equal weight” rating. (To watch Pokrzywinski’s track record, click here)
“We believe GE is on a long road to recovery under new management,” begins Pokrzywinski in the executive summary to his report. The company’s “beleaguered” Power business is set to improve over the next couple of years, while GE’s flagship Aviation business — responsible for about 25% of total company revenues, and the largest business segment within GE — “is approaching a golden age” as it builds the engines that will be needed to power a multi-year backlog of plane orders at Boeing and Airbus. Furthermore, with GE stock down some 27% over the past year, Pokrzywinski believes a lot of risk has been wrung out of the stock, and GE’s “risk/reward” ratio now appears “reasonable.”
But a lot is not the same thing as all.
Fact is, even with GE stock selling for far less than it cost a year ago, there’s still “substantial tail risk” in the stock. This includes the “many questions surrounding the complex Long Term Care insurance business.” (You probably heard a thing or two about that one last month). But it also includes worries over GE’s susceptibility to changes in interest rates (GE is carrying $110 billion in debt on its books after all), worries about eroding market share in the Power business, and about the strength of long-term demand for companies dependent on the fossil fuel industry as well.
And of course, there’s also the “softening macro environment” in general, as the world struggles to adjust to the ongoing trade war between the U.S. and China. If a recession arises, it’s going to be no better for GE’s business than for anyone else’s.
Sure, from a “sum-of-the-parts” perspective, GE stock looks attractive. Tallying up the worth of the several entities that make up GE, Pokrzywinski figures the whole should be worth somewhere between $8 and $12 (hence the middle-of-the-range “$10” price target). And yes, at its current share price around $8.80, GE stock is trading much closer to the low end of Pokrzywinski’s intrinsic value calculation, than towards the high end. Ordinarily, muses the analyst, Morgan Stanley would “view 10-15% upside as sufficient to justify a constructive view” (i.e. a “buy” rating).
Just not with GE.
Given his failure to clearly endorse GE stock, it’s worth highlighting that Pokrzywinski does not subscribe to the “LTC bear case” mooted last month, which asserted that GE’s Long-Term Care business will need to take charges to earnings to raise its claims reserves by $18.5 billion in future years — on top of the $15 billion hike in reserves announced just last year. Regardless, Pokrzywinski thinks there is still sufficient uncertainty about GE’s potential future losses from insuring the long-term care of elderly patients, as to make GE too risky to recommend based simply on its “fundamentals” (such as a sum-of-the-parts valuation). Even if “$18.5 billion” isn’t the right number for GE’s potential future liabilities, Morgan Stanley thinks another charge to earnings of, say $4.3 billion, is still a distinct possibility.
And just the possibility that there’s another multi-billion dollar bombshell charge to earnings buried deep within GE means the stock remains too risky to own. (See GE’s price targets and analyst ratings on TipRanks)