Our GE thesis is an all-out bet on industry veteran Larry Culp. We believe he is the best person to lead the long-term turnaround of General Electric. Given his outsider's pedigree, we expect he will continue his dispassionate analysis of GE's businesses and take decisive action to stop the cash burn at GE Power, address GE Capital's lingering liabilities, and position GE's remaining industrial businesses to operate from a position of strength. For proof, we point to Culp's astute decision to sell the highly desirable GE Biopharma business for $21.4 billion in cash and pension liabilities, while retaining the remaining portions of healthcare. We also believe Culp is increasingly comfortable with GE's financial situation, as shown by the team he is methodically assembling.
The GE turnaround story begins with the notoriously fickle and long-cycled power market. A successful multiyear turnaround of the industrial conglomerate won't be easy. While there are stark differences between Culp's role at Danaher, we believe green shoots of change are evident in the gas power order book.
Power continues to face both competitive and substitute threats. Renewables like wind power offer diminished environmental impacts at comparably attractive prices. The industry suffers from overcapacity, and poor capital allocation decisions forced GE to take a $22 billion write-down, exhausting nearly all of the segment's goodwill balance. GE Capital, furthermore, remains an overhang on the stock, particularly related to its insurance liabilities, as well as required additional capital contributions from industrial GE. We estimate these contributions amount to a run-rate of just over $2.6 billion from 2020 to 2023, after an additional $2.5 billion contribution in the latter half of 2019. Compounding these issues are GE's recent credit downgrades, which raise GE's borrowing costs on over $100 billion of interest-bearing liabilities.
Ultimately, we expect Culp will position GE's operating business for long-term success by aggressively cutting costs, implementing the proposed separation of BKR, exploring further asset sales, and driving operational improvements and working capital management.
General Electric was once heralded as "America's most admired company." While we agree there is a lot to admire about the company, we no longer believe it merits a wide economic moat and are downgrading its moat rating to narrow. Morningstar's definition of a wide-moat company is clear; a wide moat exists when we have a high degree of confidence a company can achieve normalized excess returns over at least the next 10 years, and more likely than not over the next 20 years. As it stands today, we no longer have that confidence in GE.
Labeling GE a wide moat oversimplifies three critical issues: secular pressures facing power and renewable energy; the firm's capital position as it pares assets; and lingering liabilities related to GE Capital. While the firm's aviation and healthcare segments certainly have moats, we think it will be challenging for GE to isolate the less desirable portions of its portfolio and lift its ROIC profile without adverse consequences. GE has about $105 billion in borrowings, and by our count, underfunded pension and other postretirement liabilities of just over $21 billion. When GE disposes of assets, these obligations must attach somewhere, and the firm can't attach them to chronically underperforming cash burning businesses like GE Power. Some of these will attach to disposed assets, as in the case of about $400 million Danaher is assuming with the purchase of GE Biopharma. GE will use the cash from asset dispositions to pay down its interest-bearing liabilities and satisfy credit ratings agencies threatening additional downgrades. Even so, the firm is also losing one of its higher growing healthcare assets in GE Biopharma going forward.
Aviation undoubtedly meets the definition of a wide-moat business and is GE's crown jewel. The segment benefits from intangible assets, switching costs, and scale-driven cost advantage. GE essentially competes in a duopoly in both the wide-body (twin-aisle) and narrow-body (single-aisle) space against Rolls-Royce and United Technologies, respectively. Including GE's 50% interest in its joint venture with CFM, we estimate that GE commands well over 40% of the combined narrow-body and wide-body engine markets, as measured by new deliveries. The aviation segment, furthermore, operates on a razor-and-blade model. A GE engine is present in two of every three commercial departures, and the firm's installed base between GE and its joint ventures reaches 37,000 engines. In the formative years after a new engine launch (about one third of the overall cost of a new plane), GE will typically implement an estimated 70% discount on its new narrow-body engines from their listed prices. Over time these discounts erode. A typical jet engine will then first require service in about year seven of operation at which time an engine program may pass break-even and become a recurring and enviable profit stream for GE (in the LEAP engine's case, management anticipates NPV breakeven in 2021). These bespoke service contracts typically extend 25 years into the future. We believe intangible assets are particularly critical for engine deliveries–the razor in the razor-and-blade model. The technical knowledge needed to design and manufacture a jet engine is GE's main source of intangible assets. This technical know-how is supported by the firm's research and development budget, of which about one third is principally funded by the U.S. government. Other intangible assets include the firm's patents, a long track record of success, and its customer relationships with both Boeing (primarily) and Airbus. A track record of success can have a disproportionate impact in delivery wins. For example, according to Bloomberg, in 2017, about 46% of Airbus' A320neo jets powered by competitor Pratt & Whitney's GTF engine (counterpart of CFM's LEAP 1-A) were out of service for a least one week in August of 2017 (compared with 9% for GE). These delays allowed GE to outpace Pratt in 2017 new A320 jet engine orders by 10-to-1, and further allowed GE to increase its market share for such orders to 60% (a 5% increase over historical norms).
Relatedly, switching costs are strongly associated with aftermarket sales – the blade in the razor-and-blade model. GE's switching costs are a result of the firm's engines and associated equipment's strong integration into customers' airframes and landing systems. In the United States, aircraft engine inspections are both mandated and regulated by the Federal Aviation Administration, and unplanned downtime related to concerns over an engine's efficacy can wreak havoc for airlines, both in terms of time and expense. This high cost of failure ultimately increases customer loyalty. By our count, nearly 61% of GE's commercial aviation revenue stems from its services, which we believe represents strong evidence of customer reliance on GE as the original equipment manufacturer. Moreover, GE's pursuit of rate-per-flight hour service agreements, whereby OEMs like GE receive service payments based on flight hours, both boosts returns and solidifies switching costs. With flight hour services agreements, GE receives payments over the life of a contract. Additionally, because OEMs assume the maintenance risk, firms like GE, Pratt, and Rolls Royce are incentivized to increase on-wing time. According to Aviation Week in late 2016, the LEAP's predecessor, the CFM56-7B demonstrates an industry-leading 99.96% percent engine dispatch reliability rate, which equates to only one delay or cancellation every 2,500 departures. Furthermore, that engine can stay on-wing for as many 20,000 cycles (typically 18,000). Cost advantage from scale is also evident in GE Aviation's margins, which exceeds Pratt's by about 12.5 percentage points, or in the R&D it can leverage not just across its power segment with its gas turbine units, but also previous-generation jet engine models.
Healthcare is currently GE's second-best business and one we think also merits a wide-moat rating, even with the absence of GE Biopharma within GE Healthcare's Life Sciences division.
Medical imaging, which constitutes about two thirds of GE healthcare's revenue base, is a notoriously opaque industry and increasingly commoditized, but one where we think GE also benefits from intangible assets, cost advantage from scale, and switching costs. GE's medical imaging installed base is large at over 1 million units. From our conversations with industry experts, GE and its competitors consolidated the industry, acquiring competitive threats like well-regarded x-ray machine maker Picker in the 1980s. Two major players have dominant share in the market, including GE and Siemens (within the 20%-plus range). Practically speaking, moreover, our experts inform us that GE and Siemens are the only two vendors actively considered by large hospital networks (with notable exceptions like Hologic's mammography machines). Doctors may go as far as choosing their residencies based on the reputation of these machines, particularly CT scans, both in terms of quality and service reliability. Indeed, most large U.S. hospitals will have a reputation of being either a "GE hospital" or a "Siemens hospital." Our belief is that this reputation obviates some of the pricing pressures that may naturally occur in more rural markets, where price is far more important given availability of resources. Given the critical functions these machines perform, their high cost of failure, and a doctor's familiarity of use, hospitals loathe switching providers for a less expensive alternative. These switching costs are reinforced by GE healthcare's massive footprint, which allows the firm to expeditiously service any faulty equipment and avoid any disruption to patient care.
Another advantage of having acquired makers of different machines is that both GE and Siemens attempt to sell hospital procurement departments an entire suite of machines. GE's economies of scale afford it the privilege of hiring a large salesforce of specialists for each types of units, including MRIs, X-rays, CT scans, ultrasounds, and mammography machines. Moreover, while it is our understanding hospitals will often pool procurement resources to increase bargaining power when negotiating with medical imaging providers, GE mostly continues to directly negotiate with each hospital. We suspect it retains its bargaining power by not disclosing pricing and requiring hospitals to sign non-disclosure agreements regarding any pricing information, keeping confidential what was once common knowledge in the industry two decades ago. Finally, GE's digital software is well-integrated with machines, which also reinforces these switching costs. Physicians less often read x-rays from hard copy film, but instead rely on GE technology to read these images digitally in a single image repository, often in a different location from where a machine may be located. While a third-party software vendor could in theory operate with GE machines, our understanding is that this solution is far less than optimal.
After aviation and healthcare, however, GE's competitive position fares far worse, with many of its other business lines facing secular pressure. GE power, the firm's other large segment (largest by revenue, number three by segment profit) faces three long-term issues: 1) overcapacity in the industry; 2) pricing pressures; and 3) a shifting energy mix in its end markets toward renewables (as well as operational issues). Grouping together its power and renewable energy segments, we think of this super-segment as a no-moat business. While power operates in a three-way oligopolistic market (along with Siemens and Mitsubishi) , GE's renewable energy competes in a fractured industry with other wind turbine manufacturers (onshore and offshore wind revenues represent about 95% of renewable energy's portfolio). Moreover, while GE power touts its 7,000-plus gas turbine installed base, and the fact that it currently powers more than 30% of the world's power, the segment has at times fallen to number three of global gas turbine orders by energy capacity in 2018. This is behind narrow-moat rated Siemens and the joint-venture between no-moat rated Mitsubishi and Hitachi within our coverage, and significant share losses mean this segment is even more competitive than we previously had appreciated.
Furthermore, GE was late to realize the inevitable transition from fossil fuels to renewables, which is predicted to compete with fossil fuels subsidy-free from a levelized cost of electricity standpoint. Wind turbines don't require the same maintenance needs as gas machines, which is where GE has traditionally made money on its long-term service contracts. We think these cost dynamics threaten to obviate the competitive benefits GE derives from its massive installed base in gas turbines, particularly as renewables also offer a far more attractive and minimal carbon footprint. According to the Financial Times, while natural gas narrowly beat wind power for new generation capacity in 2016, worldwide GE sales of large gas turbines dropped appreciably over a nine-year cycle (from 134 in 2009 to 102 in 2017). Using data from statista, market expectations, including the U.S. Department of Energy, materially under-forecast, by 383%, the energy usage and production of wind generation over a ten-year period. Under Jeff Immelt, GE failed to appreciate these risks, and we suspected its ill-time purchase of thermal energy provider and grid company Alstom will continue to weigh down the segment's ROICs, including goodwill, for years to come due to this overcapacity. Power is forced to continue restructuring efforts to counteract this dynamic as demand for new gas orders is now expected to be as low as 25 to at most 30 gigawatts in 2019 compared with 40 to 45 GW articulated at the start of 2017. As if that were not enough, however, GE renewable energy suffers from many of the same competitive dynamics that plague GE power, including even greater price competition to gain market share, and cheaper alternatives from other forms of energy, like solar, and depends heavily on production tax credits. As such, we don't believe it's a business with durable competitive advantage.
For oil and gas, in which GE continues to own a 50%-plus interest in through Baker Hughes (and plans to for the next two to three years), we also don't believe it has a moat. The GE-Baker Hughes merger created large goodwill balances, and in our view, the kind of transformative impact necessary to generate economic profits on this inflated invested capital base is not a reasonable base-case scenario. Moreover, neither Baker Hughes or GE was able to previously forge an oilfield-services portfolio on par with the quality of industry leaders Schlumberger or Halliburton, even as they were fairly acquisitive in the decade prior to the merger. Similar to the entirety of GE, we think portions of oil and gas, like the turbomachinery and digital solutions subsegments are moaty, but we conclude that economic profit generated in these lines of business will be more than offset by economic losses in oilfield services and oilfield equipment. In oilfield services, which is essentially equivalent to pre-merger Baker Hughes, we believe oil and gas will continue to remain a step behind competitively. Pre-merger Baker Hughes saw market share decline in many key product lines as competitors like Halliburton focused on U.S. shale, allowing them to overtake Baker Hughes in completion equipment, while Schlumberger took the lead in drill bits with its Smith acquisition. In oilfield equipment, and specifically subsea processing and boosting, which potentially reduces deep-water development costs by slashing project infrastructure requirements, oil and gas failed to win the lion's share of limited subsea processing projects launched thus far. We think this has been a key contributor to oil and gas trailing Cameron's operating margins in recent years.
Finally, GE Capital has been an albatross around the company's returns, and in our view, is not only a no-moat business, but ultimately has been a liability for the company. The exception would be GE Capital Aviation Services, or GECAS, which has been the one bright spot for the segment. According to Bloomberg, with more than 1,300 leased aircraft, GECAS retains number-two market share behind AerCap in terms of estimated market value of its owned and managed fleets. In financial services, however, what matters is asset quality, which can hamper profitability during a recession. On this metric, GECAS has fared well, with reported segment profits declining only 14% from 2008 to 2009 (GECAS typically earns just over $1 billion per year). Even so, this is a competitive business without any natural barriers to entry, and Chinese lenders are willing to underprice competitors like GECAS and AerCap. Other portions of GE Capital, moreover, have not fared nearly as well. Most notably is its long-term care insurance business. While GE has not originated any new policies since 2006, the Kansas Insurance Authority is requiring the firm to contribute an additional over $9 billion to its insurance reserves over the next six years after already contributing $3.5 billion in 2018 (after a $1.9 billion injection in 2019). These problems are exacerbated in a low interest rate environment as investment income can fall below projected returns. On the expense side, GE is also encountering claims that were underwritten with poor assumptions, including the life span of policyholders, or the cost of healthcare.
Bottom line, we expect that GE Capital will continue to incur charges as it restructures and in 2019, as well as from the impact of GAAP insurance accounting rules. In the short term, we believe this will mask the earning power of the firm's moatier assets. That said, we conclude that by year five in our model, GE's returns will substantially improve from recent historical experience.
After reviewing GE's third-quarter results, we maintain our fair value estimate of $11.70. We think the latest results are another data point in support of our long-term thesis: GE has valuable assets and CEO Larry Culp will be successful in orchestrating a long-term turnaround of the firm. Our fair value estimate is also now nearly in line with our SOTP value of $12.30. We also raise our diluted adjusted EPS to 62 cents per share, about a penny ahead of CapIQ consensus, or about a nickel higher than our prior estimate. We also model slightly positive 2019 free cash flow growth toward the lower end of guidance. The stock now nearly trades in line with both our fair value estimate and our SOTP value.
Our revised fair value estimate implies a forward P/E of 19 times our adjusted 2019 total GE EPS estimate. However, these earnings net out restructurings (among other adjustments), which are likely to continue for several years, as well as impairment charges. We continue to implement the impact from the Wabtec merger, the sale of GE Biopharma to Danaher, and the separation of GE's remaining 36.8% interest in Baker Hughes.
In our view, the important contributors to GE's industrial portfolio are GE Aviation and GE Healthcare. In Aviation, we think robust revenue passenger kilometer growth will drive demand, which we believe is front-end-loaded for midsingle digits over the next two decades. Finally, we use our share assumptions and our commercial engine market forecast to derive our explicit GE engine sales projections. For GE Aviation overall, we believe sales will grow at a 6.7% CAGR over our explicit forecast.
As for GE Healthcare, GE's other moaty line of business, we currently assume key market drivers include both increasing demand for healthcare services from emerging economies outside of the U.S., as well as increasing healthcare expenditure from an aging U.S. population. We also think the imaging market between the top two players in Siemens and GE, will remain relatively intact. As such, we assume GE can relatively maintain share on the strength of new product introductions and its installed base.
As for segment profits, we still assume a recovery in power margins to 9% by 2023, but assume pricing pressures translate to a new normal, both for power and renewable energy. For total segment profit margins, we think GE will reach about a 13% bogey at the end of our explicit forecast, but prior to any corporate items and eliminations.
We think the chief risks for GE are: GE's significant cash burn in some of its operating businesses, including GE Power (which burned through negative $2.3 billion in 2018 after segment restatements); liabilities at GE Capital, particularly from its legacy insurance operations; additional capital contributions from GE required to support GE Capital's operations amid asset sales; the SEC investigation related to GE's accounting for long-term service agreements; execution risk when implementing the separation of some of GE's assets; and shareholder lawsuits.
We're also increasingly concerned about rising claim experience in long-term care insurance, which rose nearly 19% through portions of 2018. While these were offset by raising discount rate assumptions (from 5.7% to over 6.0%), we don't believe it's prudent to raise a rate just to remain in line with peers, particularly as we find these assumptions aggressive and highly subjective. An example of GE aggressive assumptions include the $55,000 amount per policy versus the more than $90,000 it costs for a one year stay in a private nursing home room.
We assign GE's management a Poor stewardship rating, primarily based on previous management's record of value destruction under prior CEO Jeff Immelt and GE's opaque accounting. We are reserving judgment on current management before any ratings upgrade. While prior CEO John Flannery and current CFO Jamie Miller laudably took noticeable steps to improve earnings quality, GE continues to overly rely on adjusted non-GAAP figures, which are prone to greater manipulation after multiple adjustments and simply confuse investors. That said, we are strong supporters of Larry Culp's leadership given his long and proven track record of success and execution, exception reputation for candor and transparency, and ability to effectively communicate his strategic vision to the market.
In a complete surprise as to timing, but not as to selection, Culp was appointed Chairman and CEO of the company on Oct. 1, 2018. Culp was previously the CEO and President of Danaher Corporation from 2000 to 2014. Under his stewardship, Danaher's stock rose about 465% against the S&P 500's approximately 105% gain. Culp was responsible for helping evolve the Danaher Business System, taught strategy at Harvard Business School, and served in a variety of advisor roles at prestigious firms. Although we prefer that the two roles remain separate, we like the choice of Culp given his pedigree operating an industrial-healthcare conglomerate. We assumed he was the logical choice to succeed Flannery when he was named Lead Director. Replacing Culp as Lead Director is Thomas W. Horton, who served as Chairman and CEO of American Airlines from 2011 to 2013.
In October 2017, Jamie Miller was appointed CFO. Miller rose quickly through the ranks, having joined GE only in 2008. We like her background and believe this role is a better fit than some of her roles since she first joined GE (like CIO, where she had no discernable background in her resume in technology). Prior to joining GE, Miller was a partner at PwC and served as controller of WellPoint (now since renamed Anthem). Since joining GE she has served in a variety of roles, including chief accounting officer and CEO of GE Transportation. We were impressed with how quickly she learned key aspects of the business, which was highlighted during a special call on Nov. 13, 2017. Only two weeks into the CFO job she had a clear, demonstrable command of some of the key issues facing GE, as well as several key metrics. That said, we were concerned she oversold her visibility into GE Capital's liabilities during the length of tenure. On July 31, (during the second-quarter 2019 earnings release), GE announced that Miller will leave GE once a replacement candidate is identified. We speculate that Culp will call on his former CFO at Danaher, Dan Comas, to serve as Miller's replacement.
We applaud Culp for taking decisive action, particularly in obtaining selling GE's Biopharma business to his former firm Danaher for a very favorable price. We believe he will successfully execute GE's current plan to rationalize the firm's global footprint, rightsize headcount, institute lean initiatives, and position its operating businesses for long-term success. As Culp has indicated, GE is in the very early innings of a recovery. Nevertheless, we trust Culp's very capable operating acumen and his ability to bring both lean discipline to GE, while focusing on the voice of the customer. While we admire Culp for his proven track record, we continue to monitor GE's progress before upgrading our stewardship rating.
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