- General Electric's industrial operations are performing wonderfully.
- The company is also making the right moves with its financial operations.
- We like shares quite a bit.
General Electric (NYSE:GE) has been in the news quite a bit as of late. The industrial and finance conglomerate reported fantastic fourth-quarter results January 17 that revealed significant order and backlog expansion (two indicators of future financial performance). The fundamental momentum the company has shown recently with respect to its industrial operations is undeniable.
The company is also making the right moves with its financial operations. Having suffered through a dividend cut during the financial crisis, GE is now wisely seeking to shed (in an initial public offering) the reason why it was forced to slash its dividend payout years ago, its consumer financial services company (to be named Synchrony Financial). Synchrony isn't all of General Electric Capital Corp (GECC) - GE currently owns 100% of the common stock of General Electric Capital Corp (GECC), GECC currently owns 100% of the common stock of GECFI and GECFI currently owns 100% of the common stock of Synchrony - but the move is consistent with the company's overall strategy of reducing GECC's percentage of GE's total earnings and increasing GECC's focus on its commercial lending and leasing businesses.
According to recent reports, Synchrony could be valued at as much as $25 billion in an initial public offering and would represent the largest IPO since that of Facebook (NASDAQ:FB) - assuming Alibaba doesn't go public first. GE plans to list 20% of Synchrony and spin off the rest to GE shareholders in 2015. After the IPO (GE filed for the IPO March 13), Synchrony Financial will trade under the symbol SYF. Needless to say, we're huge fans of this move and believe it de-risks GE significantly (reducing exposure to future endemic credit crises), while reinforcing the strength of its common stock dividend ($0.88 per share annually, 3.5% yield). We'd like to see GE keep its powerhouse industrial operations and retain only the financial segment wherewithal to help finance the purchases of industrial-related goods. This business-model approach is common across much of the industrial space, at firms such as Boeing (NYSE:BA) and Caterpillar (NYSE:CAT), for example.
Assessing GE's Valuation
Looking at General Electric's industrial businesses alone, industrial earnings from continuing operations before income taxes totaled roughly $8.8 billion in 2013. The comparable mark for all of GECC, adjusted for non-controlling interests, is $8.26 billion. Disclosures at Synchrony indicate GE will be spinning off $3.142 billion in earnings before provision for income taxes (see page 15 of Synchrony's S-1 here). Therefore, the adjusted pro-forma 2013 numbers for GE, post-Synchrony IPO, indicate a company with $13.9 billion in earnings from continuing operations before income taxes in 2013. General Electric's effective tax rate has been 9.8% and 11.9% in 2013 and 2012, respectively. Assuming the firm continues at that tax rate (about 11%), pro-forma 2013 earnings (last year), post-Synchrony IPO, after taxes, would be roughly $12.38 billion ($7.83 billion - industrial; $4.55 billion - finance).
In the context of GE's fantastic pace of industrial orders and record-high backlog, applying multiple of 20 times on GE's expected industrial earnings of $9.4 billion on an after-tax basis in 2014 (a 20% growth rate) is somewhat optimistic but very reasonable, in our view. We can note several industrial conglomerates with much less-attractive order and backlog profiles trading at high-teens earnings multiples, and we don't think these comparables (3M (NYSE:MMM) or Honeywell (NYSE:HON), for example) have as much margin-expansion potential as that of GE at present. Such analysis implies a $188 billion valuation on the company's industrial operations alone. Adding the estimated proceeds related to Synchrony via its expected IPO, according to recent estimates ($25 billion, 13 times the Synchrony's 2013 net earnings of $1.979 billion), and applying a now de-risked (post-Synchrony IPO) 18 times multiple to the remainder of GECC ($4.55 billion x 18 = $82 billion), we arrive at a consolidated present value of GE of $296 billion, or more than $29 per share. GE ended 2013 with 10.162 billion shares outstanding.
Said differently, we think the spinning off of its consumer finance unit - Synchrony - will allow the market to place a higher multiple on both its industrial operations and remaining GECC unit. We acknowledge that GE's industrial operations are cyclical, but we think long-term normalized earnings are far greater than what they are at present (hence, the higher-than-market multiple). We also acknowledge that we are assigning a rather optimistic multiple for GECC (excluding Synchrony), but we think the ongoing de-risking of its financial service operations will allow it to attain a hefty price tag on any further divestitures as transparency is vastly increased via the process. We think greater transparency translates into higher valuations, especially with murky financial operations. Our analysis is further backed up by our discounted cash-flow derived fair value of GE, which is $31 per share. Both valuation processes imply material upside from the company's share price of about $25 at the time of this writing.
We think CEO Jeff Immelt knows the multi-year earnings potential behind GE's industrial operations and the potential market-value upside of its financial operations as it sheds the more-risk variety. Immelt invested his entire 2013 cash bonus in GE shares, picking roughly 105,000 for more than $2.64 million (a move that followed a purchase of 40,000 shares in January). In his own words: "I am investing right alongside you." From our perspective, we wouldn't have it any other way. With its healthy annual dividend yield of 3.5%, GE remains a holding in both the Best Ideas portfolio and Dividend Growth portfolio. We like shares quite a bit. Get ready for the ride!
Additional disclosure: GE is included in the actively-managed portfolios.