GE: Still a Compelling Proposition for Value Investors

As with the rest of the market, GE’s (GE) stock has rallied significantly off its March closing low ($6.66, 3/5/09). Maybe more comforting, the stock now seems to have firmly developed support above $10 per share. While not significant from a fundamental standpoint, $10 stocks are sometimes a key threshold for certain mutual funds or a significant psychological threshold for many retail investors.

I mentioned in a previous post about GE’s good fortune after surprisingly poor headlines (a dividend cut and the loss of its sterling credit rating) that the stock may no longer be within the risk tolerance of its traditional investor base - conservative, income oriented investors. GE’s stock, however, should be very compelling to a new set of investors - value investors.

Crude GE Cash Flow Valuation

GE Cash Flow from Operating Activities was reported as $19.1 billion in 2008. This includes $2.4 billion dividend from GECS which we can conservatively assume will be zero in 2009. This would imply that cash generated from its “traditional” businesses - infrastructure, consumer & industrial, and NBC universal - was $16.7 billion in 2008. Net CapEx in 2008 was $5.0 billion down from an average of approximately $9 billion in 2007 and 2006. Crudely speaking, GE ex-GECC had $11.7 billion of free cash flow in 2008.

With no growth and a 10% discount rate, this implies $117.0 billion in value. GE ex-GECC carries only $13.2 billion in debt leaving $103.8 billion in value for equity. GE’s current market cap $115.53 billion @ $10.94 per share. Does this mean GE is fairly valued or maybe even slightly over valued? Maybe. Maybe not.

Let’s not forget that this crude valuation assumes that the non-GECC business will never grow again AND that the Company will never receive value from the GE Capital business ever again. The flip side of this argument is that there remains some risk that GECC will parasitically poach cash flow from GE’s core business for several years in order to service its significant debt burden ($193.7 billion in debt). The Company did, however, announce 90% of its 2009 long term debt needs were financed, ostensibly the most difficult year for the Company to raise funds.

Some may also point out that GE’s infrastructure and NBC units are not likely to repeat their 2008 performance in 2009. Do not forget, however, that a cash flow valuation relies not on short term performance, but long term performance. Using a more representative model, we could assume that GE’s cash flow will decline in 2009 and then return to a growth rate more in line with GDP, very conservatively 2%. To target the $117 billion rate, GE’s cash flow could fall to $9.6 billion in 2009, or 18% from 2008’s level.

A Confirmation Valuation

I’ll admit, the discounted cash flow used above is rather crude. As such, let’s use another valuation methodology and try to confirm the conclusions above. We’ll break GE’s non financial businesses into three segments - infrastructure, consumer & industrial, and NBC.

The GE Infrastructure segments (Technology and Energy) recorded segment profits of $14.2 billion in 2008. This actually marked a 13% increase of 2007 with growth coming mostly from increased orders in the Energy businesses related to oil and gas. The businesses included in this segment are probably most comparable public comps such as United Technologies (UTX) or classified by Yahoo! Finance as “Conglomerates” which trade at a 9x multiple. Apply this multiple to profits of $14.2 billion and you get a public market valuation of $127.8 billion.

GE Consumer & Industrials business reported $0.4 billion in segment profit in 2008, down 65% from 2007. The best comp to this business might be Royal Philips Electronics (PHG), unfortunately this business actually reported a loss in 2008, a testament to GE’s performance in this segment. Philips is included in Yahoo’s “Consumer Goods / Electronics” segment and has an average P/E of 18. Thus, applying a similar valuation to this segment, we get a $6.4 billion valuation.

NBC/Universal reported segment profit of $3.1 billion in 2008 roughly flat with profit in 2005, 2006, and 2007. Disney (DIS), owner of the ABC media network and the Disney studio entertainment business is likely the best public comp to NBC/Universal (the NBC TV and Radio network and Universal Studios). Disney trades at a 9.55 P/E which would implie a value of $29.6 billion for NBC Universal.

In sum, we get a valuation of $163.8 billion for each individual GE business segment excluding the Capital Finance segment. Segment profit does not include income tax provision, interest and other financial charges, and corporate overhead. To be conservative, we’ll attribute 100% of corporate overhead to the core segments ($2.7 billion). Since Capital Finance made up 32% of profit in 2008, we’ll only take 68% of income taxes (.68*$3.4 billion = $2.3 billion). And, we’ll assume the majority of interest and financing charges are a result of GE Finance and thus will not include it in the valuation of the other businesses. Our blended earnings multiple on the segment valuation of $163.8 billion is 9.2x and, thus, we must adjust out 9.2x $5 billion in additional expenses resulting in a total valuation of $117.8 billion. Remarkably close to our valuation in the discounted cash flow above, don’t you think?

Conclusion

From the two valuation strategies used above, we find that GE’s stock currently trades at a level which basically assumes zero value for the GE Capital Finance business and potentially no growth in its core business. That is, you can buy GE Capital Finance and as well as any growth in one of America’s leading consumer products, infrastructure and media businesses for free. It would seem to me that GE shares continue to offer a very compelling value proposition to new investors.

Full Disclosure: Author is long shares of GE at the time of writing. No other positions in stocks mentioned in this post.

Comments

[malach hamo...:]

cash flow is not as significant right now as the marks it still has to take on its loans and other financial assets in GE Cap.

There are plenty of cf positive companies which are sitting on monster bombs

GE is just one of them, and until it can demonstrate that the financial business will be real-money profitable, you can't consider it either a growth or a stable investment.

Apr 06 08:45 AM

[The Curious...:]

Cash flow wouldn't necessarily be affected by marks in the GE Capital business. It would, however, likely require GE to reserve additional capital in case the marks turn into true performance. The MTM write downs for GE is understandably lower given the fact that it does not trade its securities; does not originate CDOs, SIVs, or CDSs; and does not originate mezzanine or high-yield debt. They do have significant consumer credit exposure (29% of the portfolio) across mortgages, credit cards, small business, autos, etc. But, I would guess that this diversification will prevent the eye popping writedowns that you saw with other banks. Further, the paying back of loans in the other 71% of the portfolio will likely cover losses as long as GE has the capability to refinance debt and thus buy time for its assets to perform.

Let's not forget that GE Capital was, in fact, cash flow positive in 2008. While it will not be delivering dividends to GE in 2010 (and possibly 2011), this does not mean that the unit will not be profitable, only that it will be retaining earnings to shore up its capital base. In fact, as of a March 19 presentation, the Company projects profitability in the finance segment for Q1 2009 and 2009 overall.

Apr 06 09:19 AM

[retiredengi...:]

GE CAP is in big trouble and when they start writing down all their commercial loans you'll see the cash flow go negative fast. Lets wait and see who is right, but i'm not a buyer of ge here or at 5.

Apr 06 10:38 AM

[tk77mann:]

The huge potential writedown uncertainties in GE's portfolio of consumer and industrial debt, plus their very recession-impacted, shaky customer base in their industrial sector (aircraft and airlines. at least), make GE a very questionable investment IMO. We can not even determine by looking at their balance sheet what the potential risks are. Thus they are like many of the other financial stocks, a blind bet with lots of potential risk.

I think Value Investors want a significant margin of safety, and GE has a huge, unpredictable downside. There are just too many other low debt, fairly recession-resistant, high cash flow businesses to invest in to take a chance on GE.

Apr 06 12:04 PM

[palladin:]

i owned ge in the 94-00 years and growth occurred largely due to the finace business although the other segements performed well. But most net income came from the finance biz. With mark to mkt acct desired but with the fasb give and take perhaps the finance arm can figure a way out of the debt dilema given the interest expense paid. interest coverage(tie)does not look the best if another shoe should drop in the economy like cc defaults that amex talks about. the BIZ WEEK article this week argues for selling off some assets and reducing debt which someone ought to be doing since the present ceo seems to be hand tied. a return to the go go years is not likely anytime soon and green is good but not a beachhead short term- maybe buy an oil company with light sweet crude? I took another position recently because they seem undervalued respective of the core businesses as alpha says. Just kidding about the crude but wind and greengives only about 2 and maybe most 10% of global needs in next 10 years. See royal dutch shell 50 year plan. And solar green?- leave the cadmium telluride toxic solar panels of first solar in other countries- nimb or us sw deserts.


On Apr 06 09:19 AM The Curious Investor wrote:

> Cash flow wouldn't necessarily be affected by marks in the GE Capital
> business. It would, however, likely require GE to reserve additional
> capital in case the marks turn into true performance. The MTM write
> downs for GE is understandably lower given the fact that it does
> not trade its securities; does not originate CDOs, SIVs, or CDSs;
> and does not originate mezzanine or high-yield debt. They do have
> significant consumer credit exposure (29% of the portfolio) across
> mortgages, credit cards, small business, autos, etc. But, I would
> guess that this diversification will prevent the eye popping writedowns
> that you saw with other banks. Further, the paying back of loans
> in the other 71% of the portfolio will likely cover losses as long
> as GE has the capability to refinance debt and thus buy time for
> its assets to perform.
>
> Let's not forget that GE Capital was, in fact, cash flow positive
> in 2008. While it will not be delivering dividends to GE in 2010
> (and possibly 2011), this does not mean that the unit will not be
> profitable, only that it will be retaining earnings to shore up its
> capital base. In fact, as of a March 19 presentation, the Company
> projects profitability in the finance segment for Q1 2009 and 2009
> overall.

Apr 06 03:01 PM

[Titus Andro...:]

Good article TCI. There is no doubt in my mind that GE is a great long investment. I don't think people realize exactly how a company of this magnitude works. GE's resilience throughout 2009 will create a warm fuzzy blanky for all the chicken sh!tz to climb aboard. GE Capital is a blip on the radar that is being dealt with. If anyone thinks GE Capital could potentially lead GE to their demise, they don't have a clue.

Apr 06 06:50 PM

[jstratt:]

Thanks for your analysis!

I am betting on GE getting through this rough period and demonstrating its true potential value. That said I sold 20% of my holding today. I remain holding 25% of my intended long term stake in GE.

We have some financial oriented pain and it comes in waves. When the next wave rolls in I will pick up some more shares.

One of the harder things is to believe in a company as I do GE and yet not get greedy. If you are patient you should be able to pick up more GE below $10 a share.

One day a few years down the road it will restore most of its dividend and trade for $30 a share. In the meantime try investing an amount each month and dont fall in love with it.

Apr 06 08:35 PM

[cannedpawn8:]

Too much debt...not for me

Apr 07 05:06 AM

[Buy and Hol...:]

Yeah, even if you assign a value of zero to GE Capital -- which is just ridiculous, you can't tell me that business has no value -- the remainder of the company is priced very inexpensively. So, you get all of GE's industrial/media properties at a low price and you get the GE Capital arm for free.

That's not too shabby.

If you're concerned about taking a stake in GE, I'd suggest you help yourself sleep a little better by using covered calls. You can keep on rolling those over and gain a little income every month from it.

Apr 07 08:29 AM

[DonFurio:]

Are there risks, sure, but unless GE really screws up, I strongly believe GE will be in the 20s in a few years. That would be a return justified by the risks.

Apr 07 11:33 AM

[RE- RE:]

30's DonFurio. I think alot of people will be sorry they didnt buy GE at $10. In 2010 everyone should realize that GE is a good safe investment, unfortunatly for them it might be to late. Titus Andronicus hit the nail on the head. The majority of investors are scared.

Apr 07 12:08 PM

[Alan Young:]

I agree, there's much to like about GE's core business, and the price is a bargain, if that's all you need to know.
--BUT--
Here's the catch: is GE financial worth 0? Or is it actually a liability which will continue to drain capital from the core business--making it worth LESS than 0? There's no way to know, so this is still a risky investment, IMO.

Apr 07 12:17 PM

[logicalman:]

of course GE is risky....but did anyone out there ever make REAL money on anything that wasn't..imo GE is a very conservative risk..i for one own some,and will buy more on any significant dip!!!
[ 10% or more ]

On Apr 07 12:17 PM Alan Young wrote:

> I agree, there's much to like about GE's core business, and the price
> is a bargain, if that's all you need to know.
> --BUT--
> Here's the catch: is GE financial worth 0? Or is it actually a liability
> which will continue to drain capital from the core business--making
> it worth LESS than 0? There's no way to know, so this is still a
> risky investment, IMO.

Apr 07 03:16 PM

[James Quinn:]

seekingalpha.com/artic...

Stay far away from GE

Apr 08 09:03 AM

[PUNK:]

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Jul 13 10:42 PM