General Electric (GE) stock is reversing its 2019 trajectory as a bellwether analyst has become a bear once again.
Shares of the Boston-based company fell over 5% in pre-market trading, taking some steam out of a comeback in stock price that has marked an over 30% run year to date, following the key report from JP Morgan analyst Stephen Tusa.
"We believe many investors are underestimating the severity of the challenges and underlying risks at GE, while overestimating the value of small positives," Tusa said in a note on Monday morning.
"The driver of the downgrade is our view that the Street is significantly over projecting the bounce in FCF in the coming years, off levels that we calculate at zero currently, as Power/Renewables remains weak, GECS will likely consume material cash for the foreseeable future, Aviation fundamentals, as per underlying FCF, are weaker than meet the eye, while lingering sector high leverage including entitlements leaves the company vulnerable to liquidity issues in the event of a recession, for which a potentially dilutive sale of the rest of Healthcare may be needed," he added.
He called out his fellow analysts, pondering the reason for so many to cut free cash flow estimates, but stubbornly maintain price targets.
"After implying 2019 should have minimal impact and cutting to -$1 billion on free cash flow, some Sell Side Bulls are now cutting '20 from what had been about $6 billion to now $3 billion (still too high, in our view) while maintaining numbers of >$7 B in '21, which we view as unrealistic," he concluded.
Tusa added that recently announced sale of the Biopharma business to Danaher (DHR) might not provide the relief that many investors expect.
As a result of the problematic outlook that is going unrecognized, he set a paltry $5 price target for the stock and downgraded to a "Sell" rating. His rating is now the lowest estimate among Wall Street analysts.
The move from Tusa is particularly pertinent to shareholders as he is an analyst with some of the best access to the company and has also acted as a bellwether for the share price.
On December 13, Tusa backed off of his "Sell" rating and upgraded to "Neutral", essentially marking the bottom for the stock late last year. Shares have run about 50% to the upside since this call.
STOP TRADING! Tusa Goes from Sell to Hold $GE...the bottom is being put in. Congratulations to one of the most amazing, incredible calls of a lifetime, to sell GE... Steve Tusa from JP Morgan. Research at its best. Maybe best ever..— Jim Cramer (@jimcramer) December 13, 2018
CEO Larry Culp further encouraged investors by touting a turnaround by 2020 and positive free cash flow in the struggling power business by 2021.
"It's going to take some time, and we won't be finished come New Year's Eve, but if you give us a little bit of time we will, I think, make a lot of progress," Culp told Jim Cramer on Mad Money in mid-March.
Tusa now expects that the company may be over-promising again and might not actually have the time it needs to fix the key metric ahead of a potential recession by 2021.
He compared the situation the one seen by Rolls Royce (RYCEY) amid its 2013 to 2016 decline, eschewing comparisons to his top sector pick Honeywell (HON) and a more bearish comparison to the defunct Tyco Int'l.
"Looking at Rolls Royce shows how the standing stock price at GE gives more than enough credit for any snap back, in a situation with far less macro support and more challenged leverage, but one which we think is instructive nonetheless," Tusa explained.
He noted that the multiple for the company collapsed from around 40 times forward earnings to just 15 times as more visibility on its cash flow issues came more clearly into view. Tusa expects a similar trajectory could well come into play as more stock watchers recognize the remaining issues.
"Given a low quality of earnings, we believe free cash flow remains the most relevant metric for valuation, on which the stock screens as expensive," Tusa explained as motivating his reversion to a pessimistic outlook. "While these challenges are better understood and the debate has become more balanced, as opposed to being overlooked by most Bulls in the past, we see a real bear case in potential recession for a materially lower equity value than even our base cast price target implies, given high leverage, and mechanical math around entitlements. Given the significant move in the stock since December, the risk/reward has tilted back negative, and we are again Underweight."
Tusa is well known for his consistently correct calls to the downside as the company floundered under former CEOs Jeff Immelt and John Flannery. He held onto a "Sell" rating for the stock for over two years as shares lost three quarters of their value.
As such, investors would be wise to expect share erosion to come. History has a way of repeating itself.