General Electric (GE) is a $235B company that provides products for the energy, healthcare, transportation and finance markets. It is also one of the most popular stocks on the market, which has shed some underperforming business in the past few years. While the stock is down over 75% from its 2008 highs of $40, now presents a fundamentally sound opportunity to add it to your portfolio.
DCF Analysis Demonstrates GE is Slightly Undervalued
Using a discounted cash flow model to calculate stock value per share shows GE is currently slightly below fair value. The EPS of GE is currently $1.52, and the average analyst estimate for growth is 11.1% for the next five years. Beyond five years, the model uses a future growth rate of 3.2%, which is the past five-year growth of the S&P 500, and a discount rate of 12% (the average expected return of S&P 500). This model is fairly conservative, and it yields a stock value per share of $24.54, which is a 9% margin from its current trading price.
GE's P/E Ratio Is Currently in-value
The following graph overlays GE's PE Ratio with TTM Revenue for the past five years.
The graph shows that when GE's revenue was falling, the PE bottomed out below 5. However, with the stabilization/recovery of revenue in the past three years, GE has typically traded between a PE of 15-20. The Current P/E Ratio of 17 is in-line with past expectations, and presents a fair opportunity to buy. GE's five-year average P/E is 14.5, however this is heavily influenced by the 2009-2010 range when the PE did not break 15. If GE should dip, it would present an excellent buying opportunity.
Also, notice the 2012 Revenue performance. You can see that while GE revenue dropped in 2009, 2010 and 2011, it made a turnaround in 2012 and is now projecting growth for the next five years. This is a strong signal that GE finally has momentum back to deliver the promised growth in the future years.
GE Profit Margins are Improving
In recent years, GE's margins have been an area for investor concern. In the past 10 years, GE's Gross margins have fallen from levels above 60%, to the low 50s. However, the company has seen a turnaround in the past few years, with yearly increases since 2009.
GE's Net profit margins have also continued to increase, delivering a 30% increase from 2009-2011, and recently delivered its first margin over 10% since 2007 ((TTM)). GE's CEO Jeffery Immelt has included expansion of GE's margins as one of his key focus areas for growth in 2013, and is keeping the company focused on continuing to deliver and improve on their performance. It was one of the key points he highlighted in the Earnings Report.
The Diversified Machinery industry has an average profit margin of 7%, and GE has only slipped below this margin one FY- namely 2009. Since that time it has continued to improve and deliver above-average margins, even while navigating significant revenue drops. The focus on margin improvement by the CEO will serve the company well in the next fiscal quarters, as it returns to revenue growth with an eye on driving profit margin.
GE's Business Returns are improving, but still an area to watch
GE's Business returns have also been an area of concern for past several years. GE's current 11% Return on Equity is below the Diversified Machinery Industry ROE of 12.60%, and also below its own five-year average of 11.66%.
However, in the past three years you can see GE has been turning the trend around, and delivering better value to management. This is an area that must be closely watched, but the recent trends are re-assuring that management has been making the correct moves to provide greater returns.
GE Is Returning to Dividend Growth
GE has a very sordid dividend past, having slashed dividends by a staggering 68% in 2009. Prior to February 2009, dividend growth was regularly met and prized by shareholders. After the dividend cut, GE held constant payouts for over a year, until announcing a hike in July 2010. Since then, the company has returned to historical form, making dividend increases five times over the past three years. Its last increase for its payout was a 12% increase per share to the 0.19 it currently pays.
One thing to watch is GE's Payout Ratio. Dividend growth is normally a concern when the payout ratio exceeds 50% (red zone). With GE's last increase, it has returned to the edge of the "danger zone," which may put future increases on hold until additional revenue can be generated to sustain higher payouts.
GE's Free Cash Flow Remains Strong
GE currently has over $15B of Free Cash flow, and has consistently remained in a strong position, bottoming out at $13.9B in 2006.
This cash flow enables it to pursue the emerging markets for Industrial areas that will prove essential to achieving the growth projected in the future years. Specifically, GE has been investing heavily in the Energy marketspace, and is primed to become an industry leader in power generation. It has not only invested in "traditional" turbine based power plants, but is also heavily involved in both the Solar and Wind markets, which will be a key growth area internationally. The Free Cash Flow puts it in a strong solvency position to keep the company moving forward in these domains.
GE Has Improving Debt Ratios
Generally, a current ratio of over 1.5 signals that a business is in a strong operating position. Additionally, investors should look to invest in companies that are working to decrease their debt-to-equity position.
GE's current ratio has remained at or above 2 for nearly all of the past 10 years, which is an outstanding track record. In addition, it has been increasing over the past five years and GE's current 2.7 ratio is a very strong operating position.
GE's Debt-to-Equity ratio has been steadily decreasing over the past few years, which is a sign that it has been able to identify growth while reducing debt. GE has a five-year Debt-to-Equity ratio average of 3.6, and even the recent pop back above 3 is well below its five-year average.
GE's Cash Conversion Cycle has rebounded
As GE supplies many different machinery goods, it is good to review its long-term Cash Conversion Cycle performance. This cycle is essentially a measure of the amount of time it takes between when a company spends cash on product until it receives cash back from a sale.
Interestingly enough, 10 years ago GE was maintaining a negative CCC, essentially meaning it was being paid for goods before it was delivering them. This is about as good as it gets, as it did not have to keep inventory on hand; orders were being paid before completion. However, this changed drastically in 2006-2008, when GE struggled to turn inventory into cash and the cycle spiked to over 300 days. Since that time, the cycle has clearly recovered, and is currently only around two weeks.
GE Has One of the Lowest PEG Ratios in the Industry
It's hard to clearly define GE's competitors, since it is exposed to so many markets. However, a quick look at those companies that could reasonably be called competitors for their major markets shows GE has the second-lowest PEG ratio, only behind Honeywell (HON).
A historical look at GE's PEG shows that it has traded in the same range in 2008, and it spiked in 2012 to a high near 20. Right now, GE's PEG ratio offers a fair entry point for the industry.
As habit, it's always good to also check a company's performance against a set of academic-related metrics to serve as a spot-check of fundamental analysis. These easy metrics can shine a light on any financial problems that may need further research.
First is the Piotroski score, which leverages the academic work of University of Chicago Professor Joseph Piotroski. He devised a simple scoring mechanism to measure nine simple tests, and give a binary rating against each. His research proposed that firms scoring between 7-9 should typically outperform the market. The GE Score is 8, which is a Pass.
Next, the Altman Z-Score, which is another academic metric based on the work of Edward Altman from NYU. His research creates a scoring mechanism that has been demonstrated to predict company bankruptcy risk. If a company scores greater than 2.99, it is considered financially safe from distress, while anything under that requires further investigation into the company's long-term viability. The GE score is a 1.18, which is considered a score normally indicating Distress. In order to better understand GE's situation, a look at the long-term score is valuable:
This chart demonstrates that GE's Z-score has been improving since 2008, and that the company has never been out of the "distress" zone. Based on the cash flow position, current ratio and improving Debt-to-Equity ratio, I believe this is a nature of the way GE operates in its industry, and it is not in danger of bankruptcy over the next several years. It would have been cause for concern if GE had been above 3, and then plummeted down into the current range.
Last is the M-Score, an academic metric based on the work of Messod Beneish of Indiana University. This research provides an indicator of risk that Earnings have been manipulated to paint a more favorable picture of performance than should be recognized. An M-Score of less than -2.22 suggests the company is not manipulating earnings and requires no further investigation. The GE score is -2.62, which is a Pass.
GE is poised to return to revenue growth, and has demonstrated recent improvements in its business margins. It is currently undervalued, and will be an above-average dividend addition to any long-term portfolio.
Disclosure: I am long GE.