Shares of Boeing (BA) have soared 80% this year as the company capitalizes on an aerospace super cycle with an ever increasing backlog of 787 and 777x orders. At the Dubai air show, Boeing received another $95 billion in orders, confirming the boom in aerospace and Boeing's continued reclamation of share that had been lost to Airbus (OTCPK:BAESY). However after the massive rally in BA shares and its 24x multiple, it is fair to ask if Boeing is pricing in all of this good news. That is why I think investors may want to buy General Electric (GE) as a derivative play on the aerospace boom.
GE builds the engines for the Boeing 777x that received the bulk of the air show orders. With over 450 GE engines orders at the Dubai show, the company received $26 billion in orders, adding significantly to its backlog (summary of the orders available here). Importantly, these orders typically come with service agreements that provide revenue for upwards of 15 years. These massive orders came mostly from just three airlines, Emirates, Qatar, and Etihad. As Boeing starts selling the 777x to U.S., European, and Asian airlines, the orders of GE's engines will keep growing. At the end of last quarter, the entire GE backlog stood at $229 billion. The Dubai air show increased the entire company's backlog by 11.35%.
Right now, GE aerospace accounts for roughly 20% of industrial revenue and is becoming a larger part of the company with annualized sales growth of 12% (revenue breakdown available here). Over the next three years, GE aviation should continue to grow by double-digits as the company tries to meet its ever-growing backlog. Over the next three years, GE aviation's revenue growth will translate to 3% revenue growth for the entire industrial conglomerate. With oil and gas growing just as fast, these two units could help the company grow industrial revenue by 5% annually, a major acceleration after years of stagnation.
With GE aviation a perfect derivative on the aerospace boom, it makes sense to give it a profit multiple similar to BA, giving it fair value of roughly $100 billion, leaving the rest of GE with a market value of $175 billion. This leaves investors with a variety of industrial segments and GE Capital, which has finally found solid footing with an ability to pay dividends to the parent again after shrinking to a sustainable size. If you valued GE Capital at its book value, a relatively conservative estimate, the final arm's value would equal $84 billion. The remaining industrial segments are then worth $91 billion. With profits of $10.5 billion, the market is giving them an extremely low multiple of 8.7x.
If you credited GE industrial with just a 15x multiple, that is an additional $66 billion in value, giving shares of GE an additional 25% of upside to about $32-$33. After a rough five years, GE is on the cusp of a major reacceleration thanks to the company's exposure to the boom in aerospace with GE aviation just as much of a beneficiary as Boeing. Nonetheless while shares of BA have rallied 80% YTD, GE is only up 28%. As Boeing sells more planes, GE will be selling more engines and the lucrative maintenance contracts than engines require.
Despite this, GE remains extremely conservatively valued, likely as investors struggle to deal with all of the moving parts in the conglomerate. GE aviation is quickly becoming the most important segment of General Electric's operating unit as it accounts for 20% of revenue, and by 2015, will be above 25% as it works through its engine backlog that could keep factories running for two years without another new order. By giving its aerospace unit the same valuation that the sector now commands, and giving GE Capital credit just for its book value, it is clear that the remaining parts of GE are left incredibly undervalued, leaving investors with significant potential upside.
While Boeing will get all of the headlines from the Dubai air show, GE was just as big of a winner with orders for its engines totaling $26 billion. Despite its exposure to the aerospace super cycle, investors are not giving the stock nearly as much credit as Boeing. As such, I would look to buy GE to profit from its aviation unit while also purchasing extremely strong other businesses that are chronically undervalued. There remains significant upside in GE shares.