General Electric (NYSE:GE) was one of the most severely hit companies during the financial crisis of 2008. The conglomerate was broadly expanding into the financial services sector in order to take advantage of the opportunity. However, as the financial meltdown started, the stock started losing value rapidly and the company lost more than half of its value.
Over the past two years, GE has made substantial recovery in its business; as a result, the stock price has shown considerable recovery. Going forward, I believe there are a number of positives for the company and the stock price will continue to move higher. My optimism is based on the recent movements made by GE and a change in strategy, which I believe will pay sizeable dividends in the future.
What will Lufkin Acquisition Bring to the Table?
On 8th April, GE announced its intention to pursue the acquisition of Lufkin Industries Inc. (NASDAQ:LUFK) for $2.98 billion. By doing so, the company will be substantially expanding its oil and gas segment, making it the third largest manufacturing segment after Power & Water and Aviation. The deal values Lufkin Industries at $88.5 per share. Jeffrey Immelt, the CEO of the company, had announced that GE would be looking for such acquisitions to increase the exposure of the company to the sector. Also, as pointed out by a number of analysts, such acquisitions are expected from a number of large companies with strong cash flows as this seems to be the best possible approach to pursue growth in the presence of low interest rates.
The global oil and gas sector is experiencing a unique form of progress. According to 2013 Outlook on Oil & Gas by John England, Managing Partner at Deloitte, the most important recent developments of Oil & Gas in US include shale gas and tight oil which have been made possible by the remarkable technological advancements. This transformation and growth of the oil and gas sector is likely to assist the growth of GE, specifically after the acquisition takes place.
Change in the Strategy and Growth in Earnings
Earlier in February, GE sold its stake in NBC Universal and also took steps to reduce the high financial risk associated with GE Capital. High exposure to GE Capital was the prime reason for the fall of the company in 2008 - the segment makes the company highly sensitive to financial shocks and also to macroeconomic fluctuations. Clearly, the idea is to firstly reduce the dependence on GE Capital and taking GE back to its traditional business along with expansion into other growing sectors by putting the spare cash to use.
In 2012, the company posted operating earnings of $16.1 billion producing a CAGR of 17.6% in the post financial crisis period. On April 19th, the company is expected to announce the results for the first quarter of 2013 - average Analyst estimate is $0.39 per share for the quarter. The cash flows and the profitability of the company support the decisions to pursue strategic acquisitions. Keeping these factors in check, analysts are currently suggesting an average of 10.7% upside.
Fundamentals, Margins, Dividend and Risks
GE's five-year average net profit margin is 9.26% as compared to the industry average of only 2.57%. Cash flows of the company are also strong as it generates operating cash flows of $31.3 billion. The company currently operates at a P/E of 16.61 as compared to the industry average of 19.32; forward P/E for the company is 11.8. Furthermore, GE's P/B ratio has crawled up from less than 1 in 2008 to 1.95 at present.
The company also offers a strong dividend yield of 3.22% making it extremely desirable for income investors. Dividends for GE have been growing slowly but consistently over the past few decades. In 2012, the company paid $7.4 billion in dividends producing a 15% increase in per share dividends. These factors are expected to play a vital role in shaping the future performance of GE.
So far, we have looked at the future prospects and impressive performance of the company; however, this performance is subject to a few risks that need to be considered as well. Most importantly, the company's dependence on GE Capital is still very high as the segment contributes substantially to the company's annual revenues. However, the company is slowly shifting towards its traditional business, indicating that lessons have been learned and this risk might decrease in the future. However, as long as the restructuring is in process, the company's performance remains sensitive to macroeconomic risk factors.
I have been extremely impressed with the recent movements made by the company. GE is trying to exploit high-growth sectors, and more focus is being put to the industrial arm of the conglomerate. Taking into account the future growth prospects, GE is trading at a discount, in my opinion. The emphasis on strategic acquisitions along with strong fundamentals, undervaluation of stock and substantial dividend yield make GE an attractive stock for investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.