There seems to be a strange dichotomy in the world of Wall Street these days. Fears of economic collapse in Europe and weakness in the US are clouding the Street's perceptions of corporate earnings, which have held up very well this quarter. Wall Street, for whatever reason, has difficulty recognizing the reality that many companies do not need strong economies in Europe and the US to prosper. One such company is in our portfolio today, and we think now is a great time to invest.
General Electric (NYSE:GE) is one of the world largest corporations, employing hundreds of thousands of people and sells its products all across the globe. It is a conglomerate with interests in a myriad of industries, such as finance, manufacturing, and healthcare. As such, GE has a unique feel for the pulse of the global economy. So what is GE saying? GE is saying that things are fine, and will be going forward. Despite this, GE shares have barely budged over the past year. However, we think that going forward, GE shares will outperform as investors see the solid fundamentals of this company.
GE has many catalysts going forward, which we will highlight below:
- Record backlog. GE grew orders in the 3rd quarter by 16%, and the backlog has reached $191 billion, a company record. Book-to-bill, a key measure of demand, was at 1.07. Frankly, these results are inconsistent with the thesis that the debt crisis in Europe or the US economy will destroy corporate earnings.
- Emerging markets. As a global company, GE has a diversified revenue base, and is not dependent on any one region to support future growth. On the conference call, CEO Jeff Immelt, when asked about demand in Europe, stated that "I think Europe we're going to stay cautious on Europe. U.S. is surprisingly strong. Our orders in U.S., as Keith [Sherin, CFO] said, were very solid. And then the growth in the emerging markets are booming, so we see phenomenal demand globally.
CFO Cherin also weighed in, stating that "I think our strength clearly is in the emerging market, so you can see the orders growth. We've invested, localized our business, globalized our business. I think the team is doing a great job of that. I think U.S., as you said, is a little better than we thought, and we've got to do a good job executing there." GE does not need Europe all that much going forward. Emerging markets are still going strong, and GE is uniquely positioned to help emerging economies industrialize and grow. The US economy, it is important to note, is still growing. While GDP growth is nowhere near as high as it should be, GDP is growing, and that is helping GE.
- Firm commitment to double-digit EPS growth in 2012. GE is committed to its growth targets. Deane Dray, an analyst at Citigroup, pressed for evidence of how GE will achieve this, asking "This new projection of double-digit earnings growth in 2012 really puts GE among the very few companies today to draw the line in the sand and say you can have that kind of earnings growth, and it's certainly welcome news. But could you share a little bit more of the assumptions, most importantly, kind of the geographic splits, core revenues?"
CEO Jeff Immelt and CFO Keith Sherin said: "I'll start with GE Capital, Deane, just say kind of arithmetically we continue to progress. The returns expand -- the returns stay high on the E&I base, and the amount of the red offsets run off. And so I think from a GE Capital standpoint, a double-digit growth is kind of arithmetic. And then when I look at our big -- 2 big businesses, Aviation and Energy, extremely strong backlogs, tremendous product profiles, really good geographic mix, and I would say comparing to at least in the case of Energy, easier comparisons in 2011 versus 2010. So I like the way our 2 big industrial businesses are positioned. But I particularly like the backlogs and how they're positioned. From the standpoint of Transportation, kind of more of the same as it continues to expand in Healthcare I described earlier. So our belief is we ought to see very attractive organic growth and expanding margins industrially in 2012. And a lot of our positioning is in growth markets. So a lot of our orders strength and a lot of our positioning is there."
- Defensive stance towards Europe. GE, in its earnings release, has clearly outlined its exposure to Europe, and we like what we see. GE has just over $17 billion in financing assets in what it calls "focus countries." (Focus countries are the PIIGS.) It has minimal sovereign debt exposure and 85% of assets are backed by collateral. Furthermore, GE Capital has not seen any meaningful rise in delinquencies from Europe. Furthermore, given GE's cash hoard, it is well positioned to acquire assets on the cheap should the opportunity present itself.
- Fortified balance sheet. With close to $138 billion in cash on the balance sheet, and debt maturities supported by enormous cash flows, GE has taken great steps to repair its balance sheet from the damage of the financial crisis. It has redeemed Berkshire Hathaway's (NYSE:BRK.A) preferred shares and has been steadily growing book value, which currently stands at around $11.70 per share. GE Capital has a strong capital position, with a Tier 1 capital ratio of 11%, a position enhanced by continued deleveraging.
- Capital allocation and valuation. While GE has not restored the dividend to pre-crisis levels, it is working hard to reward shareholders. The dividend has been raised 3 times since being cut, and is currently at 15 cents/share, yielding nearly 3.7%. We feel that given GE's strong growth profile, the dividend has plenty of room to rise. GE has also been actively buying back stock, and we see this as continuing. The stock is very cheap when compared to its long-term outlook. GE trades at a P/E of 13.39, and a forward P/E of about 10.3. GE's price-to-book ratio is under 1.4, reflecting the deep mismatch between GE's potential and its present stock price.
We think now is a great time to add to or initiate a position in GE. The company is committed to growing earnings and revenues at a double-digit pace, has outlined its European exposure, and is wonderfully positioned to capitalize on growth in emerging markets. GE is bullish on the global economy, and we are bullish on GE. Analysts agree with our outlook. Credit Suisse sees the shares reaching $22, S&P sees them reaching $20, and Argus sees them reaching $26. The Reuters average price target is $20.79, representing upside of over 27% from current levels. GE believes in "imagination at work." And we believe that GE will work wonderfully in your portfolio.