General Electric (NYSE:GE) has had a rough start to 2014 with shares down over 8% (see the chart below) as investors are increasingly worried about growth in emerging economies. Clearly, CEO Jeffrey Immelt thinks that GE is now trading at a significant discount to its fair value as he spent his cash bonus buying shares. In total, he spent $2.6 million buying over 100,000 shares (details available here). I think Immelt is correct to be optimistic at current levels because GE is exposed to major growth areas like aerospace and oil services while shrinking GE Capital to a manageable size. Based on a sum of the parts analysis, GE shares should trade $32-$35. They are a great buy here, and I would follow Immelt into the stock.
(Chart from Google Finance)
GE has a portfolio of leading manufacturing companies that are market leaders and are showing solid growth. While overall operating revenue was flat last year at $146 billion (financial and operating data available here), net earnings jumped 3% and several units have strong growth prospects. Moreover, operations are improving with organic sales growth of 5% in the fourth quarter. Orders were also up 8%, which should translate to higher revenue this year. I expect organic revenue growth in the 3-6% range in 2014, powered by two units in particular.
First, its Oil and Gas unit increased revenue by 11% to $17 billion. Pre-tax profits also jumped 13% to $2.2 billion. With a boom in US production in areas like the Marcellus Shale and Permian Basin, I expect strong drilling activity for the foreseeable future. We have also seen a firming in commodity prices, which will make more projects economical. While the end of the winter should cut natural gas prices in the near term, prices will remain high enough to make increasing supply a profitable endeavor, especially as the U.S. slowly begins exporting LNG. This unit should continue to grow revenue and profits by 10% annually. I expect earnings to grow 13-15% this year. With its growth profile and peer valuations, 17x forward earnings would be a reasonable valuation. As a stand-alone unit, it is worth $37 billion.
GE is also a leading supplier to Boeing (NYSE:BA) as it makes the engines for the Dreamliner 787, which has seen extremely large orders. GE's aviation unit will be running at capacity for at least another five years just to meet the order backlog. Further thanks to consolidation, commercial airline operators have been relatively profitable, which does minimize cancellation risk. Last year, aviation revenue jumped 10% to $21.9 billion with growth accelerating in the fourth quarter to 13%. Profitability also jumped 16% to $4.35 billion in the year. As it eats through its backlog and gets higher maintenance revenue (which lags production growth), I expect Aviation profits to grow 12-15% in each of the next two years, and this unit could account for 25% of GE's industrial revenue in 2015. In this sense, GE is a great play on Boeing and the aerospace super-cycle. With its growth and peer valuations, GE Aviation is worth $90-$100 billion.
GE is also working down its GE Capital unit that caused so many problems during the financial crisis. The unit has strong capital ratings (Tier 1 common of 11.4%) and can once again pay dividends back to the parent. GE is leaving riskier consumer businesses and focusing more on financing purchases from its industrial units. As such, GE Capital's growth will be more closely tied with the performance of GE industrial's operations. Like most banks, I would value GE Capital at roughly its book value, which stands at $83.7 billion.
Together, Oil & Gas, Aviation, and Capital are worth about $215-$220 billion. GE currently has a market capitalization of $257 billion. That means GE's other industrial units are being valued at roughly $40 billion. In fact, these units will generate over $11 billion in profits this year. Even at 12x earnings, that suggests GE is undervalued by $80 billion or 30%. Based on these valuations, GE should be trading in the low to mid $30's. Just because GE is big does not mean it cannot grow. It is positioned to profit from major growth industries like aviation, oil, and even healthcare. As such, it has the capacity to grow earnings by 8-10% in each of the next three years. Immelt is buying GE because he sees value. Shares are valuing GE at a significant discount to the sum of its parts, and I would follow him into the stock.