Technology is likely to be one of the first beneficiaries from signs of a full recovery. As an investor relations consultant, I see indications of greater investor awareness for undervalued electrical equipment/ tech companies Panasonic Corp (PCRFF.PK) and Keltron Corp (KTRN.PK). The industry's giant, General Electric (GE), will, however, receive most of the attention, unless press coverage changes. It should be noted that GE is a conglomerate and encompasses a variety of different industries - notably, finance. Thus, the firm is a good indicator of where the economy is heading.
In this article, I will run you through my DCF analysis on General Electric and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Honeywell International (HON) and Emerson Electric (EMR).
First, let's begin with an assumption about revenues. GE finished FY2011 with $147.3B in revenue, which represented a 1.5% decline off the preceding year. Analysts model a 12.5% per annum growth rate over the next five years, and I view this as reasonable, since it is about in-line with that expected for the S&P 500.
Moving on to the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold to trend from 56% in 2012 to 55% in 2017, and SG&A to trend from 4.6% to 4% during the same period. Capex is estimated at 7% of revenue, and taxes at 30%. Net increases in working capital are at around $10B.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $26.19, implying 29.7% upside.
All of this falls under the context of strong performance:
"Finally, we ended 2011 with confidence that we could deliver on our 2012 double-digit of earnings framework. So overall, a good quarter. Orders grew by 15%, which was up 9% organically. We had fairly broad-based strength. Of particular note, Energy orders were up 23%. Thermal orders were up 88% and we had orders for 50 heavy-duty gas turbines in the quarter. Orders in the emerging markets grew by 26%. We end the year with $200 billion of backlog and had an equipment book-to-bill ratio of 1.23 for the quarter. So these numbers certainly support a 5% to 10% organic growth goal for 2012".
From a multiples perspective, GE is also attractive. It trades at a respective 16.4x and 11.5x past and forward earnings versus 25.9x and 12.2x for Honeywell, and 16.8x and 13.2x for Emerson Electric. Assuming a multiple of 16.5x and a conservative 2013 EPS of $1.51, the rough intrinsic value of GE's stock is $24.92.
Consensus estimates for Emerson's EPS forecast that it will grow by 8% to $3.50 in 2012, and then by 13.4% and 11.3% in the following two years. Despite recent poor performance, management still presented an optimistic outlook. It is anticipating a 20% return in capital and a record year in free cash flow. With uncertainty in orders, however, the risks are significant especially in light of the Thailand flooding. These bearish concerns will help driver higher returns.
Honeywell, however, has posted a strong performance in the recent quarter. Sales grew 7% organically as emerging markets took off, driving EPS to the high-end of guidance. Going forward, margins, ROIC, and net cash flow are all expected to increase. Assuming a multiple of 16x and a conservative 2013 EPS of $4.91, the rough intrinsic value of the stock is $73.65.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.
