GE: Buy on Valuation

Between 1999 and 2008, GE had grown EPS at 5.82% per annum. The 6 year average EPS grew at 6.48%. Dividends grew at 10.87%. Then came 2009; by the end of 2009, annualized EPS, 6 year average EPS and dividends were negative 0.67%, positive 4% and negative 2%. When you compare two points in time ignoring the period in between, you get a good handle on annualized rates, but you do not get the trend. For example, the median year on year change in EPS for GE during the 1999 to 2009 period was 7.02%; a single devastating year has caused the annualized growth rate to fall to negative 0.67%.

All in all, GE is a decent investment opportunity priced at $16. Industrials are a sector with some significant growth triggers coming from emerging market; GE is well situated to capitalize on that growth potential. The big drag on US industrials such as CAT, DE and GE is the degree of leverage. Each has a balance sheet where the debt to debt plus equity ratio is just over 80% because of their involvement in financial services. CAT and DE’s leverage is effectively an investment in growth; they finance buyers of their equipment and profit from both the “industrial” business and “financial services business”; this is not something I like, because I feel they should focus solely on their core business and leave the financial business to financial institutions.

Yet, it is acceptable because having the financial business as an option to buyers, does drive growth of the core business. In addition, because the sectors to which they supply are in fantastic fundamental condition, the credit risk is probably lower than most would like to believe. GE on the other hand has a financial business as a stand-alone core business; that I do not like; no I do not like it one bit.

For this reason, my feelings about GE are mixed. On the one hand I love their “Industrial” segment, I even like their media business, but on the other hand, I hate their “financial services” segment. Leaving aside my personal likes and dislikes, GE is very investable. Their balance sheet is much healthier than a few quarters ago. The dilution from capital raised during 2004 (for Vivendi) and 2009 (Crisis), net of buybacks (at peak prices during 2005, 2006 and 2007), has caused some dilution; share count has risen an annualized 0.75% between 1999 and 2009.

This is disappointing, but far from the end of the world. Over-all, absent aggressive credit growth, which is only to be expected in a deleveraging economy, with potentially high real interest rates, EPS growth could be restrained during the coming years. But this is priced. In the very long term, in my view, GE can grow EPS at a steady 7% (inflation plus real). I expect 2009 earnings at $1 to be an earnings trough; using a 7% long term growth rate and an investor long term return expectation of 11% and a payout ratio of 40% gives a value of $16; a value where the stock is reasonably valued.

However, $1 is likely the trough earnings figure; in my view there is a reasonable case that the 6 year average EPS will be at $1.81 (same level as 2008) by 2014. Using an investor long term return expectation of 11%, a long term growth rate of 7% and a payout ratio of 40% provides a 2014 price target of $29.05; this together with a dividend of $0.90 (based on a 40% payout ratio) provides a very good total return expectation.

To conclude, GE is a buy on valuation; several stock valuations are stretched now; GE is only begining to recover from terrible sentiment.

Please refer to GE on the Quant Report for insight into numbers referred to above.

Disclosure: Long: CAT, DE; No Holdings: GE.

Comments

[Senan:]

It's recovered quite a bit of it's share price loss since March (like the rest of the market I guess), so personally I'd hold out for a dip in the chart.

Sep 23 03:41 AM

[CaptainJJack:]

I like GE, too, but at 13 times or less, not 17 times. I like the industrial businesses, but I have never liked the NBC or finance businesses.

I think the earnings history is not very useful. Although I am clearly speculating, I believe that Welch used to "manage" earnings through the finance arm (especially when they owned Genworth), and they often made their numbers by selling things, especially the real estate investments.

Immelt does not have those options, and he is at least making an effort to rein in the cowboys at GE finance. Still, with consensus at around $1/share next year, the stock seems fully valued.

Then, too, the dividend has been cut by two thirds.

So, I like GE long term, but given the business GE is in, I think that the stock price will face a lot of hills and valleys, and I can wait

Sep 23 08:53 AM

[notsosmart:]

bought @ $ 7.61. didnt buy enough.

Sep 23 10:26 AM

[sethmcs:]

Sold 15 Oct calls @ $1.03 to exit my position at $16.00. Maybe I pulled the trigger too soon and then again maybe not. Lets see what October brings.

Sep 23 11:43 AM

[bassmaster17:]

The 2 Federal beneficiaries: Government Sachs and Government Electric...the water situation in CA as seen on Fox most likely relates to GE wanting to put solar panels in that area. America got nothing back for abandoning the missle defense system in Poland, but Jeffrey Immelt was in Russia hangin with Mendevev shortly after. Who needs fertile soil to plant crops when another connected company Monopolysanto lobbies its way to grow bioengineered crops in swamps and deserts.

Sep 23 02:10 PM

[desicon:]

Isn't the past rosy earnings were from GE finance? If so then the future may not return to the same level as you predict. Also, GE has another dud, the appliance division in their portfolio. They have to make some major portfolio re-alignment before returning to consistent earnings growth.

Sep 23 03:12 PM

[DonFurio:]

In the past earnings were about 40-50% from GE finace. However, they most likely will just have to reduce GE Finance, but not get rid of it enitirely. So even if GE Finance is 35%, they should be ok. Yea, some of their division are lower margin, but they will probably be able to sell these divisions at better prices in a year or two. I've bought some shares in the lower teens, but I'd still say it's an ok buy.


On Sep 23 03:12 PM desicon wrote:

> Isn't the past rosy earnings were from GE finance? If so then the
> future may not return to the same level as you predict. Also, GE
> has another dud, the appliance division in their portfolio. They
> have to make some major portfolio re-alignment before returning to
> consistent earnings growth.

Sep 24 08:57 AM

[Avooch:]

10 articles on GE packed with analysis. GE is a great company and worth paying a premium of 18 times TTM EBITDA as enterprise value.

That makes it a decent buy at $6

gudovac1941.blogspot.c...

----------------------...

Don't Get Massacred !

Gudovac1941

Sep 24 11:48 AM

[No1:]

Can someone comment on the GE's backlog? It was pretty big coming into the recession.

Is it being consumed without filling in new orders?

If so, if this economy remains in the slump for another 3-5 years, how will the backlog look then and what is the impact to earning?

Sep 25 11:04 AM