I have been living in Fairfield County for almost 15 years and any time I pass by a General Electric's (GE) headquarter offices I see a full parking lot and people working hard in teams or alone, often at night and during holidays. In addition, the company sponsors a number of non-profit organizations (UCONN, Stamford Public Library, Sacred Heard University, Junior Achievement, and the Norwalk Maritime Aquarium to name a few) and is overall a decent neighbor, given that 20% of the local economy depends on it. However, there are three main reasons I like GE. First, it has interesting businesses with exposure to emerging markets and growing areas such as energy and healthcare. Second, the company is recovering well after the 2008-2009 recession, and the stock, while off its low, is still a good investment from a valuation stand point. Third, the company's financial services division has been contributing steadily to GE, but this has been largely ignored.
GE has two major segments - first, GE Industrials comprised of energy infrastructure, aviation, healthcare, transportation, and home & business solutions and second, GE Capital. In 2011, GE recorded revenue of $147.3 billion of which $45.7 billion or 31% came from GE Capital, $94 billion or 64% from industrials (of which $41.9 billion or 45% is from product services) with $7.6 billion or 5% from other (of which $2 billion is from the NBC Universal - Comcast JV). Going further down the industrial chain, energy contributed $43.7 billion or 46.5% of all industrial revenue, aviation and healthcare around $18 billion each or 20%, and transportation and home and business solutions, the remaining $13.5 billion, or approximately 14%. Geographically, revenues were also diversified with $69.8 billion or 47% from the U.S., followed by Europe ($29.1 billion or 20%), Pacific Basin ($23.2 billion or 16%), Americas ($13.2 billion or 9%), Middle East and Africa ($9.8 billion or 6.5%), and other global ($2.2 billion or 1.5%). The industrials business is supported by GE Capital, as most of the items the company sells have large price tickets and GE Capital, among other things, provides the financing. In order to stay competitive, GE spends billions of dollars on R&D, and in 2011, it spent $4.6 billion on R&D, compared to $3.9 billion in 2010.
GE is the largest industrial conglomerate followed by Siemens (SI) and United Technologies (UTX) which combined together are still smaller than GE. Despite its large size, GE is able to grow its businesses as it is constantly discontinuing businesses in which it does not have a leadership position. This together with the strong R&D spending should contribute to a 7-8% growth in emerging markets and some developed markets such as Australia and Canada, according to GE's guidance. Most notable is GE's advance in China, where the company expects about $6 billion in revenue in 2012 after a 28% revenue growth in 2011 and despite a general slow-down in China's economy. The diversity of GE's businesses together with its global reach (global revenues from the industrials segment were $54.3 billion) make this industrial conglomerate a rock-solid investment.
During the past ten years GE has had its ups and downs as the economy experienced a few booms and some busts. It traded around a high of $42 to a low near $7 per share during the first quarter of 2009 (unfortunately I did not buy at that point). Its price to earnings ratio has been fluctuating from a high of 28 in 2002 to a low of 6 in 2009. On average its price to earnings ratio has been around 17, which gives a price of $20.9 based on its 2011 earnings per share of $1.23. Assuming GE earns $1.55 this year which is in accord with Wall Street estimates and a price to earnings ratio of 17 this gives a price of $26.35. Currently GE pays a dividend which yields 3.4% and it appears likely that it will stay the same or go up. Thus, investors are paid 3.4% and an opportunity for a capital appreciation of approximately 30% from current stock price in the next one to two years. This is not a conservative estimate but not overly optimistic either.
Compared to its peers, GE is also a bargain. 3M (MMM), another conglomerate, has price to earnings ratio of 15, compared to 16.3 for GE. However, on a forward looking basis, GE's price to earnings ratio is 12.9 while 3M's is 14.3 and in my opinion 3M is much riskier company due to its limited penetration in developing markets, its higher dependence on commodity prices and on the electronics market which faces pricing pressures, and relatively low level of new products. Compared to Siemens and United Technologies, GE is also better positioned for growth and I expect it will be less severely impacted by the slow-down in Europe and not at all by the slow-down in China.
GE Capital recently passed the stress test of the Federal reserve bank. It has a Tier 1 capital ratio of 10% double the required minimum of 5% and $553 billion in assets. The main reason for GE's stock share fluctuations in 2008 and 2009 was mostly the GE Capital division, but I believe the risk at GE Capital is minimum compared to the risk that the largest banks had. In fact, Citigroup (C) failed the same stress test. GE Capital should be able to resume dividend payments to the parent company and it expects to pay out 40%-50% of its net income, below the recommended maximum by the Fed of 70%. The Fed had more severe loss assumptions at GE Capital but our central bankers came up with better than expected capital return. I think GE Capital has in place good management that will not allow a major loss in this unit.
In conclusion, GE should benefit from its diversification in different industrial segments that are in demand as well as from its penetration in growth markets. The stock, at the current price level, offers good dividend yield with a potential of capital appreciation. The GE Capital unit is well positioned to support the industrial business and to contribute to the company on its own. Overall, GE is a well oiled and efficient industrial giant - its revenue per employee in 2011 was $490,000 dwarfing the revenue per employee at Siemens and United Technologies of $272,000 and $290,000, respectively. GE is a good investment and provides an exposure to growth as well. There are risks associated with GE arising from possible decrease in economic activity, higher unemployment rates, political instability, as well as internally from misallocation of resources and its underfunded pension plan, for example. However, I strongly recommend the stock as a long-term investment and/or a substitute to bond investments, which are expected to underperform in the next few years, due to the anticipation of higher inflation and interest rates.