JP Morgan cuts GE from Overweight to Neutral after reevaluating the conglomerate’s strategic position following its crappy Q1. JPM thinks GE faces considerable hurdles from the continued deterioration in the macro environment and, perhaps more importantly, the need for a “material shift in portfolio structure.”
The Aerospace aftermarket and real estate are two areas of particular concern for JPM. Aerospace looks to continue to weaken as airlines scramble to cut capacity:
GE’s Commercial Engine Services business generated $6.9 B in highly profitable sales during 2007, representing 41% of Aviation, 12% of the Infrastructure segment, and 4% of total company sales. Any cracks in the GE Infrastructure story would be negative, and we now expect a slowing in commercial aerospace aftermarket next year, which is an incremental headwind versus our model. We have reduced our Aviation sales growth forecast from ~13% to ~5% in 2009, driven by slowing aftermarket growth. We are now forecasting 2% growth for Commercial Engine Services next year, but the bias to the downside is growing with each new round of capacity cuts by the aircraft carriers, in our view.
Real Estate is another problem sector:
We believe GE Real Estate earnings will decline 25% to $1.7 B in 2008. Equity assets will decrease as a % of the total book as the company liquidates the portfolio, with gains estimated in the area of $1 B, or 60% of net income. The debt financing side, which earned $0.6 B in 2007, should grow to $0.7 B this year and even further in 2009 as GE continues to remix the portfolio toward senior secured loans at 20+% ROE. We think that gains from equity assets could fall toward $0.5 B next year, which would bring them back to the levels seen during 2005. Our assumptions are presented below.
Aside from specific operational headwinds in these two sectors, JPM is concerned about GE’s strategic direction. In order to remain competitive, JP Morgan believes management will need to drastically restructure the conglomerate’s portfolio of businesses:
From a more philosophical level, coming away from the historic GE 1Q, there is a raging debate around whether the strategy here is working. While we see no silver bullet solution, we think the time has come for management to take the hard steps necessary to re-focus what remains a competitive/competent culture and, in the process, re-ignite investor interest. Restructuring the portfolio is one way to make this happen, and while recent management commentary is a step, additional opportunities are probably on the table.
JPM rates GE shares Neutral and has trimmed 2009 EPS to $2.30 vs street consensus of $2.44.