Simplification of General Electric's (GE) industrial holdings, shrinking asset base in GE Capital ("GEC"), improving margin structure, sector leading dividend yield, and cycle tailwinds make GE one of the most compelling investment opportunities in 2014. The company has reduced risk significantly lately and the management has taken a more shareholder friendly approach. Overall the GE story is improving at a much faster rate than is generally perceived. I think the market still doesn't fully appreciate the GE potential and it is reflected in GE's valuation.
The conglomerate continues to target 70%/30% mix for industrial vs. finance earnings by 2015. The company is aggressively investing in manufacturing, while at the same time shrinking its finance business. GE is confident about its outlook in 2014 and expects profit from its healthcare, aviation, and other industrial units to increase at least 10% next year. While most of GE peers have set 2014 organic revenue growth in the low to mid-single digit range, the Fairfield, Connecticut based company, driven by record backlogs and visibility to late-cycle upticks in Power & Water and Aviation, expects to grow its organic revenue in the range of 4% to 7%.
GE also remains committed to its cost cutting efforts and to establish a leaner management structure. With its long-term ambitious Simplification initiative, the company is targeting to reduce SG&A from 17.5% of sales in 2012 to 12.0% by 2016. GE expects to achieve these targets through 30% fewer P&Ls, 30% increase in shared services, 80% fewer ERPs, lower indirect spend, and supply chain consolidation. These simplification efforts should contribute to 120 bps of operation margin expansion through 2016 (17% in 2016 vs. 15.8% in 2013). It is important to note here that GE eliminated $1.5 billion of structural costs in 2013, and is targeting further reduction of $1.0 billion in 2014 and $0.5 billion in 2015.
GE also recently increased its dividend by 16%, which increases the payout ratio above 50% in 2014. The Board of Directors approved a $0.03 increase in quarterly dividend to $0.22 per share. This implies a sector leading dividend yield of 3.3%. The increase in dividend is an evidence of General Electric's confidence its operating outlook as it shrinks GEC and invests more in manufacturing. It should help investors understand where at least half of cash will go next year.
GE has historically been criticized for its lack of direction and lack of set tangible goals for investors to measure progress against. It appears that GE's management has listened to this criticism and in its most recent outlook meeting focused exactly on goals and targets. The company expects a double digit increases in industrial operating profit and a modest decline in GEC resulting in a mid-single digit increase in EPS. Moreover, GE continues to target double-digit increases in its oil and gas segment revenue and operating profit in 2014. This is despite mixed messages throughout the sector of a slowdown in some oil & gas markets.
We have a buy rating on GE. Portfolio simplification should continue to be a powerful stock driver for GE in 2014, especially keeping in mind GE's recent announcement that it will be divesting its North American Retail Finance business in a two-part process, to be completed by end of 2015. The company also has plenty of cash and balance sheet optionality. It pays a sector leading dividend yield and its core portfolio is looking strong now after going through a rough patch. GE's end markets e.g. Powergen, Aerospace, Healthcare are in late-cycle and are still yet to inflect upwards to the same extent as peers. The management has also shown high sense of urgency to create shareholder value.
Share buybacks are a critical capital allocation focus of GE and management has set the target for a share-count of 9.0-9.5 billion by the end of 2015, down from the 10.2 billion at 3Q13. The company has also expressed its willingness to add leverage to the GE parent's balance sheet to further bolster its $90 billion of capital allocation capacity through 2016. While M&A opportunities due to the company's self-imposed $1.0-$4.0 billion bolt-on sized deals remain limited and dividend payout ratio also remains near optimal levels, this additional capital would more than likely be directed to more share repurchases.
GE's shares still appear cheap compared to its peers. However, assuming a successful spin of its North American Retail Finance business and as the company becomes more pure-play industrial stock, GE should see multiple expansion. Moreover, GEC asset reductions particularly the remaining real estate book and the non U.S. consumer finance business could provide further upside. All in all, GE is looking at a strong year ahead of it. The last time I wrote on GE I was accused of being paid by GE. I don't know what sort of reaction would I get this time but from where I see, the GE story keeps getting better.