General Electric (NYSE:GE) has been performing exceptionally well over the past two years. The stock has more than doubled during this period, and it looks like the trend in the price will continue for at least another twelve months. There are a lot of positive things happening for the company, and a focus on the industrial segment has brought this giant back on track - too much exposure to the financial sector resulted in an imbalance for the company, which cost it dearly. Nonetheless, the future direction of the company looks very promising.
Increasing Order Backlog
General Electric and the Electricity Regulatory Authority of Vietnam have signed a contract to prepare a wind grid code for increasing renewable power sources in Vietnam. A Team of GE will perform a valuation of the country's existing wind power capabilities and plans for development. This project is being funded by a technical grant from the U.S. Trade and Development Agency. The company is looking forward to make up to 6,000 MW of new wind power.
The total cost of a wind farm varies based on construction requirements, site-specific circumstances and transportation constraints. But approximate figure for a wind power generation plant costs around $2 million per Megawatt (MV). As mentioned above, GE has to provide 6000 MW of new wind power. Therefore, this order would likely add $12 billion to the existing order backlog i.e. $229 billion. So it is safe to say that GE's order backlog has now touched $240 billion.
Dividends, Cash Flows, and Revenue
When we talk about conglomerates such as GE, there is an expectation of high dividend due to the long history and soundly established business. GE, like many other giants, had to cut its dividends during the financial turmoil of 2008 - however, since then, the company has been increasing its dividends on consistent basis and after the recent increase, the quarterly dividend is $0.09 below the level before the dividend cut. At the moment, quarterly dividend for GE stands at $0.22 per share. A lot has been said about the dividend hike by GE - however, it is not wise to not take a look at the free cash flows while talking about dividends. The trend in free cash flows is the most important in my opinion in order to gauge the dividend stability of the company.
In GE's case, free cash flows have been falling for the past three years. Free cash flows at the end of 2010 stood at $26.3 billion before taking a sharp fall to $20.7 billion at the end of 2011. The fall did not stop there and the number fell down to $16.2 billion by the end of 2012. Trailing twelve months free cash flows stand at $13.6 billion. However, during the same period, the company has been able to increase its dividends, mainly because of the low payout ratio at the start - the dividend payout ratio came down massively after the dividend cut, and provided the company a good platform to increase dividends and show progress.
In the year of the dividend cut, the payout ratio for the company came down to just 18% from about 56% in the previous year. Its current payout ratio based on free cash flows stands at 56.6% (based on trailing twelve months dividend payments and free cash flows). Now, if we take into account the dividend increase, the next year dividend payments will be around $8.4 billion - if the free cash flows remain around the current year level, the payout ratio will be between 55% and 60%, which is easily manageable for a company like GE. Another important item to monitor in GE's cash flows statement is the changes in its financing (remember still a large amount of revenues and debt for GE comes from its financial arm). Over the past four years, debt repayment has been far greater than the new debt issued, which shows how the company is balancing its segments and its risk exposure.
Finally, a look at the mix of earnings for the company - for the revenue mix, I will be mainly looking at the share of GE capital and industrial segments. Total industrial segment revenues far outweigh the revenues from the financial services segment - at the end of the last year, industrial segment revenues were just below $103 billion, while total revenues from GE capital were just above $46 billion. Net income from the industrial segment was $15.4 billion and $7.4 billion from GE capital. So, only about 33% of the total income for GE comes from its financial segment. At the moment, it is an ideal mix for the company. GE capital was a drag on the company two-three years back but not anymore. There has been a massive increase in income from GE capital - at the end of 2010, GE capital contributed only $3.1 billion, which has now gone up to $7.4 billion.
After doing exceptionally well over the past two years, some investors might think that the future growth for GE will slow. However, I believe the stock will be able to continue its rise. As I have mentioned above, the mix of segments is at ideal condition now, the financial segment is contributing more and the recent increase in interest rate should further increase the interest margin, which will result in higher profit. At the same time, industrial segment has massive order backlog, which will help the company register continued growth from the segment. Both segments will add to the cash flows substantially, and I believe free cash flows will grow over the next two-three years. As a result, I believe the company will continue to increase dividends at least until it reaches its pre-dividend cut levels, and growth in cash flows should allow the company to keep payout ratio around 60%.