S&P 500 Index Bear Market: 2 Blue Chip Stocks That Haven’t Been This Cheap in Years
It’s no secret that the economy is slowing, and investors should prepare for potential bad earnings news in the months ahead. However, it is also true that stocks sold off aggressively in anticipation of this. So actions like an industrial giant General Electric (EG -1.31%) and United Parcel Service (UPS -2.29%) now look like excellent value. Here’s why.
General Electric faces risk but also offers a significant reward
The industrial giant is symbolic of the value available in the market today. There is no doubt that its short-term earnings and cash flow projections are at risk. However, this threat stems primarily from its inability to overcome supply chain disruptions in its aviation, healthcare and renewable energy businesses. Ongoing issues reduce GE’s earnings potential and push back its free cash flow (FCF) generation.
GE HealthCare (a company set to be spun off in early January) is a good example. For example, during the recent Morgan Stanley Laguna Conference, GE CFO Carolina Dybeck Happe noted that the GE HealthCare team “had a tough couple of quarters,” but stressed that the problem was not “on the demand side.” In fact, GE HealthCare’s revenue growth has been significantly dampened by supply chain issues in 2022. As such, GE now expects to generate about $3 billion in healthcare profits in 2022, compared to a previous estimate of $3.1-3.3 billion. She’s right; after all, GE HealthCare’s orders grew 5% organically in the first half, and the company is likely to stick to its backlog once supply chain issues ease.
On valuation issues, the downward revision to short-term expectations is reflected in Wall Street analysts’ consensus estimates for GE as a whole. For example, the consensus is $6.5 billion in FCF in 2023 (compared to management’s target of $7 billion). Yet even that figure ($6.5 billion) would put GE at a 2023 price/FCF multiple of less than 11 times FCF. Put another way, GE (in its current form, including healthcare) could generate 9.2% of its market capitalization in FCF in 2023. That’s a very cheap valuation for a company with good long-term growth prospects. in aviation and healthcare, and strong power demand.
With many opportunities to catch up on cash flow in its aviation, healthcare and renewable energy businesses in the future, the potential reward of buying GE stock outweighs the risk of decline from a short-term reduction in earnings/cash flow expectations.
UPS continues to transform its business
Parcel delivery is a cyclical business and any economic downturn will hurt UPS sales. Indeed, UPS’s rival fedex has already warned of deteriorating end markets in 2022. And on the latest earnings call, UPS Chief Financial Officer Brian Newman said macro conditions in the second quarter were “challenging.” CEO Carol Tomé would go on to say that the weak environment has caused US domestic parcel volumes to decline “more than expected.”
There’s no doubt that, based on comments from FedEx and signs of weakness in the economy, UPS could disappoint investors in its Oct. 25 earnings report. Still, with the stock down 23% this year, it’s hard not to think that a lot of bad news is already priced in to the stock.
A quick look at the ratio of UPS’s enterprise value (market capitalization plus net debt) to earnings before interest, taxes, depreciation and amortization (EBITDA) shows how cheap the stock is on the basis of current EBITDA.
Additionally, there is ample evidence that UPS is achieving its goal of repositioning its business to maximize profitable deliveries rather than seeking volume for volume’s sake. Additionally, UPS is focused on sweating its existing assets rather than increasing spending to drive out less profitable e-commerce deliveries. In particular, its strategy of focusing on small and medium-sized businesses and healthcare is helping to boost profits and profit margins as it moves to be more selective about deliveries. This should continue as the economy recovers from slowing growth. So on balance, now seems like a good time to invest in a company that is improving its underlying fundamentals, even if it faces near-term earnings pressure.
Lee Samaha has no position in the stocks mentioned. The Motley Fool has posts and recommends FedEx. The Motley Fool has a disclosure policy.