Why Merrill Lynch Still Sees Big Upside for GE After Earnings

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General Electric Co. (NYSE: GE) reported earnings on Friday morning, and the results came with mixed fanfare. The results looked as though they were going to be good enough for Wall Street at the opening bell on Friday, but then came selling pressure in GE shares, even as the broader market indexes were barely changed.

The analyst research team at Merrill Lynch, with Andrew Obin leading the call, has told its clients not to panic here. Merrill Lynch reiterated its Buy rating and kept its $35 price objective. Their view is that a better earnings per share report and better orders were offset by weak free cash flows.

The earnings beat came at a time when expectations from Wall Street were relatively cautious. The upside of a penny from the Industrial segment was accompanied by better growth in Power. First-quarter organic growth was 7%, improving from −1% in the fourth quarter. Core equipment orders were up 5% from a year ago, and even Oil & Gas orders were reported to be up 30%. Service orders were 9% higher and aided by Aviation growth of 17%.

Merrill Lynch did note some caution in the pricing environment and with order pricing down. The firm viewed the positive first-quarter earnings surprise as being offset by disappointing cash flows from the Industrial segment. The report said:

The company indicated that first quarter (2017) free cash flow was $1 billion weaker than its internal expectations on working capital build, driven by weaker receivables collection, inventory build in US healthcare market, and contract assets. GE maintained a full-year CFOA outlook of $18 billion to $21 billion, including $6 billion to $7 billion of GECC dividend, and this will likely be the biggest focus on the call.

Merrill Lynch sees the 2017 earnings per share framework as unchanged, after GE kept its 2017 outlook of $1.60 to $1.70 in earnings per share. The firm’s investment rationale said:

We forecast GE to post double-digit EPS growth in its Industrial business, which puts it as one of the highest growth large-cap Industrial names. The April 10 announcement of a staged exit of most GECC businesses may translate to more regulatory visibility at GECC, allowing it to upstream more capital to the parent and GE utilizing its industrial balance sheet more efficiently.

GE shares closed at $30.27 ahead of earnings on Thursday, and its opening bell price was $30.27 on Friday after earnings. In Friday’s midday session, the GE share price was down 2% at $29.65, in a 52-week range of $28.19 to $33.00.

While Obin’s $35 price objective may imply upside of 18%, that is better than most Dow Jones Industrial Average stocks get. Most analysts give upside targets of 8% to 15% in this stage of the bull market on their Buy and Outperform ratings, and GE’s dividend yield of 3.2% would put this implied total return upside north of 21%.

One last consideration on the $35 price objective is that it was above the $33.00 consensus analyst price target from the Thomson Reuters sell-side universe. That same $35 target is also just a dollar shy of the highest sell-side price target on all of Wall Street.