General Electric: Sum Of The Parts Analysis, Part II

| About: General Electric (GE)

In Part I of this series, I discussed General Electric's (NYSE:GE) Home and Business Solutions business. In this piece, we'll take a look at the company's robust transportation business. The Transportation business offers customers railroad, mining, drilling and marine industries the products they need to get their jobs done. GE provides clean diesel locomotive engines, drive technology solutions, repair services, energy storage batteries, remote monitoring and diagnostics and many other ancillary products and services. The Transportation business is well diversified and as we'll see shortly, is one of GE's best components in its vast portfolio.

Note: in order to save space here, for a description of the methodology I'm using to perform this analysis, please see Part I linked above.

To begin our analysis of the Transportation business, the segment's results since 2008 are below.

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As we can see, and what probably should be expected, the Transportation business' revenue plummeted in the wake of the financial crisis. After cresting $5 billion in 2008 the segment's revenues fell below $3.5 billion in just two years. As a result, we see operating profits plummet as well from about $1 billion to just over $300 million in the same period. The outsized reduction in operating profits given the decrease in revenues provides some clues as to the segment's operating leverage, which we'll discuss later.

After the horrible year Transportation had in 2010 the segment rebounded quite strongly in the subsequent year. Year 2011 saw revenues jump back to nearly $5 billion and operating profits soared better than 100% to $757 million. Again, this segment has tremendous operating leverage and that leverage is a strong asset for this segment.

Since the rebound in 2011 the segment has done nothing but continue to post very strong revenue and operating profit gains, producing just under $6 billion in revenue and $1.2 billion in operating profits this year, according to my estimates. That is an astounding amount of money to make given the revenue level and we'll take a look at that now.

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This graph shows the Transportation segment's operating margins for the same time period as above and the results are fascinating. In 2008, before the customer order cuts following the financial crisis, the Transportation business produced operating margins of almost 20%. When revenues began to dive that number plummeted roughly 50% to under 10% of segment revenues. However, as revenue began to rebound, operating margins followed and we see a strong, steady uptrend in operating margins at the Transportation business in recent years.

This is indicative of a very strong business with significant capacity to expand its revenues without incurring commensurately high costs. In other words, Transportation has high fixed costs, such as those required to operate factories, that don't increase in lockstep with revenues. Thus, when revenues increase, fixed costs can be leveraged to produce more revenue at incrementally higher operating margins. This is what we're seeing with Transportation and that is why the segment has produced such robust operating results in recent years.

So what is this segment worth, for the purpose of this exercise? Revenue growth is coming in at the mid to high single-digit range annually but operating profits, thanks to the operating leverage we discussed, is increasing at three times that rate per year. This business would command an earnings multiple premium if it were a standalone business due to its very strong operating results and profit growth.

Certainly, a business growing profits at this rate and the strong outlook for its respective served industries would command a premium to the broader market. With the S&P 500 (NYSEARCA:SPY) showing a trailing PE of 15, we can approximate GE's Transportation business' PE by extrapolating out taxes in order to convert the operating profits we have into earnings as traditionally defined and comparing it to the market multiple. GE's consolidated tax rate, as an example, came in at 10% (not a typo) in the third quarter of this year but assuming this business would pay that on its own is unrealistic. For this exercise, we'll assume the Transportation business' standalone tax rate would be 25%. On this year's estimated operating earnings of $1.18 billion, I'll assume the company would pay roughly $300 million in taxes. This would leave us with approximate earnings of $885 million. With the Transportation business' soaring margins and operating profits an earnings multiple of 20 to 22 wouldn't be out of the question. If we take the midpoint and multiply it by the segment's estimated earnings, we get an implied standalone value for the Transportation business of $18.6 billion.

In Part I, I determined the Home and Business Solutions business was worth about $3.8 billion as a standalone company and we've just seen I believe the Transportation business to be worth roughly $18.6 billion on its own. In subsequent pieces, we'll take a similar look at Energy Management, Power and Water, Oil and Gas, Aviation, Healthcare, and GE Capital.

Disclosure: I am long GE. 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.