General Electric (GE) and 3M (MMM) are both valued around their historical 5-year average PE multiples, but I still find room for appreciation for both companies. According to T1 Banker, the Street is more bullish about GE and rates it a "buy". Based on my review of the fundamentals, multiples analysis, and DCF model, I share the Street's preference.
From a multiples perspective, GE appears to be the cheaper of the two. While it trades at 15.6x past earnings versus 14.8x for its competitor, it trades at only 10.9x versus 12.8x. This implies that investors are not fully appreciating GE's growth on a relative basis.
At its fourth-quarter earnings call, General Electric's CEO, Jeff Immelt, noted an excellent close to 2012:
"GE finished the year with real strength. We had the best order results in history. Many of our key end-use markets are showing momentum like Commercial Real Estate and Aviation. The emerging markets continue to be very strong. There are a few challenged markets like Europe and Appliances but on balance, we have a positive outlook.
Company operations were strong. EPS grew by 11%. Organic growth was 5%. CFOA and liquidity were very strong. GE Capital exceeded all of their performance goals and ended with a very strong Tier 1 common ratio. We're executing a balanced capital allocation plan. We increased the dividend again in fourth quarter. Overall, the dividend grew by 21% in 2011. Our buyback for the year was 5.4 billion, including both common shares and the Berkshire preferred".
Orders gained 9% organically, with particular strength in Thermal (88%) and Energy (23%). Perhaps most notably, the company delivered order growth of 26% in emerging market, which mitigates relative exposure to slower-growing economies. And General Electric Capital Services, or GECS, has really turned over a new leaf. Shedding its image as a net drag, it is now a significant driver of a free cash flow having meaningfully reduced risk. Wholesale funding is also less of an issue, with deposits nearly tripling as a percent of the funding base from the historical 5% level.
Consensus estimates for GE's EPS forecast that it will grow by 12.4% to $1.54 in 2012, and then by 14.9% and 18.6% in the following two years. Modeling a 3-year CAGR of 15.3% for EPS and then discounting backwards by a WACC of 9%, yields a fair value figure of $26.55, implying 38% upside.
3M has similarly illustrated its strengths. Despite slowing industrial production, the company is still trending towards high single-digit organic returns. Although George Buckley's retirement as CEO is disappointing, innovation will continue to prevent market share erosion. According to Morningstar, nearly one-third of sales come from products released over the past half decade - a figure that is likely to increase over time. At the same time, ROIC has held solidly above WACC, due to strong capital deployment and low-cost operations. Management is positioning the firm for emerging market growth - which make up an increasing part of the business - by improving its global supply chain.
Consensus estimates for 3M's EPS forecast that it will grow by 5.5% to $6.29 in 2012, and then by 9.7% and 9.6% in the following two years. Assuming a multiple of 15x and a conservative 2013 EPS of $6.85, the rough intrinsic value of the stock is $102.75, implying 16.5% upside.
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