General Electric: Is This The Time To Invest?

May. 5.14 | About: General Electric (GE)

Summary

What are some growth drivers for 2015 and beyond.

At this time, does GE trade at an attractive valuation?

With the focus on streamlining, how does GE look from a fundamental point of view?

For investors looking for a large-cap company that is stream-lining their businesses, General Electric (NYSE:GE) is a dividend paying company that is focusing on margin expansion. The analysis below will indicate if General Electric's management is achieving this goal?

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2011 = $14.151 billion
  • Net income 2012 = $13.641 billion
  • Net income 2013 = $13.057 billion
  • Net income 2014 TTM = $12.53 billion

Over the past three and a half years, you can see that the net income has diminished. The overall net income has diminished as the company management has streamlined the company and sold off assets that they have deemed unnecessary. Over this time period, GE's net profits have decreased from $14.151 billion in 2011, to $12.53 billion in 2014 TTM, which represents a decrease of 12.94%.

  • Operating income 2011 = $34.643 billion
  • Operating income 2012 = $29.914 billion
  • Operating income 2013 = $26.267 billion
  • Operating income 2014 TTM = $25.39 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past four years, GE's operating income has decreased from $34.643 billion to $25.39 billion in 2014 TTM.

ROE - Return on Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

Net Income / Shareholders' Equity

  • 2011 - $14.151 billion / $116.438 billion = 12.15%
  • 2012 - $13.641 billion / $123.026 billion = 11.09%
  • 2013 - $13.057 billion / $130.566 billion = 10.00%
  • 2014 TTM - $12.53 billion / $131.80 billion = 9.51%

Over the past three and a half years GE's ROE has been falling. Since 2011 the ROE has diminished from 12.15% to it's present value of 9.51%.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets
    • Total assets 2011 = $717.242 billion.
    • Total assets 2012 = $685.328 billion.
    • Total assets 2013 = $656.560 billion.
    • Total assets 2014 TTM = $652.300 billion
    • Equals an decrease of $64.942 billion
  • Total liabilities
    • Total liabilities 2011 = $600.804 billion
    • Total liabilities 2012 = $562.302 billion
    • Total liabilities 2013 = $525.994 billion
    • Total liabilities 2014 TTM = $520.500 billion
    • Equals an decrease of $80.304 billion

Over the past four years, GE's total assets have decreased by $64.942 billion, while the total liabilities have decreased by $80.304 billion. This is an indication of how management is streamlining their company.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets
    • Current assets 2011 = $453.137 billion
    • Current assets 2012 = $428.729 billion
    • Current assets 2013 = $422.303 billion
    • Current assets 2014 TTM = $409.600 billion
  • Current liabilities
    • Current liabilities 2011 = $166.210 billion
    • Current liabilities 2012 = $221.403 billion
    • Current liabilities 2013 = $206.572 billion
    • Current liabilities 2014 TTM = $380.600 billion
  • Current ratio 2010 = 3.01
  • Current ratio 2011 = 2.73
  • Current ratio 2012 = 1.93
  • Current ratio 2013 = 1.08

Over the past four years, GE's current ratio bounced around. As the current ratio is currently above 1, this indicates that General Electric would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 10.678 billion
  • 2011 shares outstanding = 10.620 billion
  • 2012 shares outstanding = 10.564 billion
  • 2014 shares outstanding = 10.120 billion

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GE Average Diluted Shares Outstanding (Quarterly) data by YCharts

Over the past four years, the number of company shares has decreased. The company has decreased the shares from 10.678 billion to 10.120 billion. Representing a reduction of ~5.51%.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2011 = $79.022 billion / $147.300 billion = 53.65%.
  • Gross margin 2012 = $73.049 billion / $147.359 billion = 49.57%.
  • Gross margin 2013 = $68.904 billion / $146.045 billion = 47.17%.
  • Gross margin 2014 TTM = $58.67 billion / $145.112 billion = 40.43%.

Over the past three and a half years, GE's gross margin has declined. The ratio has decreased from 53.65% in 2011 to 40.43% in 2014 TTM.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth
    • Revenue 2011 = $147.300 billion
    • Revenue 2012 = $147.359 billion
    • Revenue 2013 = $146.045 billion
    • Revenue 2014 TTM = $145.112 billion
    • Equals an decrease of 1.51%.
  • Total Asset growth
    • Total assets 2011 = $717.242 billion.
    • Total assets 2012 = $685.328 billion.
    • Total assets 2013 = $656.560 billion.
    • Total assets 2014 TTM = $652.300 billion
    • Equals an decrease of 9.95%.

Over the past three and a half years, the revenue growth has decreased by 1.51% while the assets have decreased by 9.95%. As GE is stream-lining their company, this is an indication that the company from a percentage point of view has been more efficient at generating revenue.

As GE's management is stream-lining the company, we have to look at the company in a different light. With the stream-line philosophy in mind, looking at the company from an efficiency standpoint is more reasonable than growth.

Revenue over the past three and a half years, has decreased by 1.51% while the assets have decreased by 9.95% indicating that GE is more efficient at generating revenue with less assets. GE's TL/A ratio also indicates that GE is eliminating more liabilities than assets. Over the past three and a half years GE's assets have declined by $64.942 billion or 9.05% while the companies liabilities have been reduced by $80.304 billion or 13.36%. Even though the company is generating some positives, the analysis above is showing some declining trends. The ROE or return on equity has decreased from 12.15% to 9.51%. Another metric that is lagging is the gross margin. Over the past three and a half years the gross margin has declined from 53.65% to 40.43%. As the company is stream-lining their businesses and focusing on margin expansion the analysis above indicates that in some ways the company is achieving this and in other ways not.

As the analysis above indicates, from a fundamental point of view, GE has a "mixed bag" of positives and negatives. Looking forward, what are some key segments that will drive this company and the stock price?

Looking Forward

Currently GE is estimating aviation, healthcare and the industrial industries to lead the company into the future.

Within the industrials, GE is predicting strong growth within the railroad industry. As the rail industry is exploring the idea of switching from Diesel fuel to LNG fueled locomotives, this will provide GE with a substantial catalysts.

Currently, GE is working with Berkshire Hathaway Inc.'s (NYSE:BRK.A) (NYSE:BRK.B) Burlington Northern Santa Fe LLC, Union Pacific Corp. (NYSE:UNP), Norfolk Southern Corp. (NYSE:NSC) and CSX Corp. (NASDAQ:CSX) to reduce emissions and increase profitability in the railroad industry. In keeping with this strategy, in November of 2013 GE released their NextFuel™ Natural Gas Retrofit Kit. This first dual-fuel locomotive retrofit kit is expected to reduce locomotive fuel costs by up to 50%.

The oil and gas industry also looks to be a positive for the company over the next few years. Driven by the substantial growth in the North American Onshore drilling industry the oil and gas segment was up 27% compared to the three months ending in March 2013 leading the growth for GE in Q1.

At this point in the market, is General Electric a buy?

Valuations

In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and EV/EBITDA ratios to estimate the current value and target price for each share.

Discounted Cash Flow Valuation

I believe using the Discounted Cash Flow valuation model for General Electric to be fair because DCF analysis can help one see where the company's value is coming from and can generate an opinion based on that.

FY 2011 FY 2012 FY 2014 TTM
Operating Income 34,643 29,914 25,390
Taxes 5,732 2,504 686
Unlevered Net income 28,911 27,410 24,704
D&A 9,185 9,346 9,762
EBITDA 43,828 39,260 35,152
Free Cash Flow 20,709 16,205 15,121
WACC 6.58%
Terminal Value 15X EBITDA 527,280
Total Cash Flow 20,709 16,205 579,315
Net Present Value $512,202.59
Total Debt 380,600
Cash and Cash Equivalents 132,700
Net Debt $247,900.00
Equity Value $264,302.59
Shares Outstanding 10060
Current Value $26.27
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Even though there are variations in calculating this formula, this model is based off of a terminal value of $527.280B and a WACC of 6.58%. The terminal value of $527.280B is based off of the company trading it's two year historical value of ~15x EBITDA. Using this valuation, I have concluded GE's value to be ~$26.27 per share.

EV/EBITDA = Enterprise Value/Earnings Before Interest, Taxes, Depreciation and Amortization

In the next section, I will use the EBITDA to calculate the EV/EBITDA. The EV/EBITDA ratio is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm.

Enterprise Value or EV = Market Capitalization + Total Debt - Cash and Cash Equivalents.

  • EV - $269.306 billion + $380.600 billion - $132.700 billion = $14.458 billion
  • EV = $517.206 billion
  • EBITDA = $35.152 billion
  • EV/EBITDA = 14.71

Based on GE's EV/EBITDA two year average of 15x EBITDA, this indicates at current levels the stock is trading just under fair value compared to it's 2 year average.

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Chart sourced by Finviz

Seasonality

According to a 20-year seasonal average supplied by equity clock, the late spring and summer months are usually a season for consolidation. These months have historically offered limited capital appreciation and as the DCF calculation and the EV/EBITDA ratio have revealed at current levels the stock is fairly valued.

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Conclusion

Currently, I am bullish on the outlook for GE. With the emergence of natural gas being a primary source of energy over the next 15 years, rivaling coal and oil, GE's focus on providing products that will allow other companies to profit from this revolution will be a catalyst.

Having stated that, management is currently streamlining the company, they are focusing on debt reduction and selling off assets that do not fit with the company's current direction. As this is the case, the fundamental analysis above reveals some strengths in efficiency but some lagging in metrics like the ROE and gross margin.

At current levels the EV/EBITDA and DCF valuations state that GE is currently trading at fair value. As I expect the overall market will be choppy over the summer and potentially the fall months, the stock price in the near future could be quite volatile.

As I expect the price to become quite volatile over the next period of time, I believe this will provide an opportunity to invest in a company that is refocusing on their industrial roots.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.