Why Shares of General Electric Slumped in June

What happened

Shares of industrial giant General Electric (NYSE: GE) declined by 18.7% in June, according to data provided by S&P Global Market Intelligence. While the overall market was weak in June, GE’s underperformance speaks to the market’s fears over the industrial company’s prospects in 2022. There are two interrelated issues to consider.

First, in the first-quarter earnings call, management said GE was trending toward the low end of its full-year guidance due to supply chain pressures in its aviation, healthcare, and renewable energy segments. On a brighter note, the power segment is firmly in turnaround mode. Given that many companies are reporting worse-than-expected supply chain problems, it’s reasonable to expect more pressure on GE in the second quarter. Simply put, GE’s full-year guidance could be under threat.

Second, if GE is going to lower its earnings expectations in 2022, it calls into question the smooth flow of the breakup plan. As a reminder, GE plans to spin off GE Healthcare in early 2023 and then spin off a combination of GE Power and GE Renewable Energy in early 2024. So if GE and GE Healthcare’s earnings are under threat in 2022, then it might affect the level of debt GE Healthcare will be spun off with — companies are typically loaded with debt in line with their earnings.

So what

The ongoing supply chain problems are a concern, and management has already told investors that GE Renewable Energy wouldn’t meet management’s initial expectations for 2022. That said, GE’s valuation is now such that it can probably tolerate a moderate reduction in guidance. Alternatively, if GE merely maintains the low end of its guidance for free cash flow (FCF) of $5.5 billion to $6.5 billion, the stock will look significantly undervalued. Based on the current market cap of $70 billion, GE would trade on a price-to-FCF multiple of less than 13 times FCF at the end of 2022.

Now what

GE will release its second-quarter earnings report on July 26. All eyes will be on management’s commentary on end markets and guidance. In particular, investors will want to know if the healthcare segment is on track. Management told investors that GE Healthcare’s first-quarter growth of 1% could have been closer to 9% had it not suffered supply chain disruptions. Those conditions extended into the second quarter, and investors will have cause for concern about GE’s full-year prospects. On the other hand, the end demand is still there (overall organic orders up 13% in the first quarter), and at some point, GE will be able to fill customer orders from its $240 billion backlog. The question is, How patient will the market be while the company prepares for the healthcare spinoff?

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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