General Electric | Fundamental Analysis | LONG SETUP

If you are a millennial or older generation, you probably at least faintly remember a time when the industrial conglomerate General Electric was one of the largest and most influential companies in the world. The company was a $400 billion titan before the 2008-2009 financial crisis knocked GE down, and the company has been struggling to get back on its feet ever since.

Today, the company is in the midst of a major transformation, selling off individual divisions to reduce its business and resume growth. General Electric recently reported Q4 2021 earnings, showing that its financial performance seems to be improving. Here's what investors need to know as the company prepares for bigger changes.

Sometimes a bold move is the right move, and it's not always easy to make. In November, General Electric announced plans to spin off several divisions into their own companies, bringing General Electric's focus to aviation.

A brief description of the changes and their timing includes a GE Healthcare division in 2023. The renewable energy, energy, and digital divisions will merge and separate in 2024. General Electric will retain a 19.9 percent stake in Healthcare, but the overall deal will give shareholders three independent, industry-specific companies.

Conglomerates often trade at a discount compared to what their parts might be worth individually. A company with many different businesses has to distribute its resources, intellectual capacity, and money among its divisions. Although individually smaller, these companies can focus on their individual business models, potentially leading to higher performance and higher valuation in the marketplace.

Management's main goal has been to rebuild the company's damaged balance sheet. General Electric has paid off $87 billion in debt over the past three years and continues to make progress each quarter. In 2021, the company sold its aircraft leasing business for $31 billion (mostly) in cash, paying off the debt with the proceeds. It is also the last part of the company's financial division to be sold, eliminating what was once General Electric's most prominent business and what caused its collapse more than a decade ago.

Financial performance has yet to reach the level desired by management. As of the end of Q4 2021, the company's net debt to EBITDA ratio is 3.3, and GE wants to reach 2.0 by the end of 2022.

This ratio means that the company is aiming for $1 of annual operating income for every $2 of debt on its balance sheet (net debt means you subtract the company's cash).

The company is still working on this, but General Electric should leave any gloomy scenarios in the past because a net debt to EBITDA ratio of 3.3 is not something that should dramatically stress the business. GE even felt comfortable enough to make a $1.4 billion acquisition, buying BK Medical in 2021.

General Electric still owns additional assets that it could leverage if necessary, including stakes in Baker Hughes and AerCap totaling about $13 billion. Company executives said they intend to ensure that all three possible stand-alone companies have investment-grade balance sheets.

There are plenty of moving parts to General Electric's financial performance, including ongoing restructuring in divisions such as energy and renewables to make them more profitable, as well as the lingering influence of GE Capital. However, investors can focus on free cash flow to get a general idea of how things are going.

After generating about $600 million in adjusted (non-GAAP) free cash flow in 2020, General Electric has increased free cash flow to $5.1 billion in 2021. Management expects $5.5 billion to $6.5 billion in 2022 and more than $7 billion in 2023.

Free cash flow is vital to the business because it is real money that the company can use to strengthen its balance sheet or for acquisitions, something General Electric is actively pursuing. Many unique items can affect a company's earnings over time, so investors may want to focus on free cash flow.

The fallen giant's reputation and various financial moves seem to have discounted General Electric stock. Free cash flow of $5.1 billion against a market capitalization of $107 billion values the stock at a price-to-earnings ratio of 21.

Other industrial companies are trading at higher valuations, such as Honeywell with a P/FCF ratio of 26 and Eaton Corp with a ratio of 36. That valuation seems fair given General Electric's current position, but long-term investors may want to consider the potential value opening up as a result of the upcoming spin-offs.

It's hard to say what valuation the market will see separately for the aviation, medical and energy companies. Nevertheless, as sentiment around General Electric improves and the company's financial performance improves, investors may benefit from management's big plans.