Why GE Is Undervalued

 |  About: General Electric Company (GE)
by: Steven Towns

We are rapidly approaching General Electric's (GE) 2012 annual meeting on the 25th. If you haven't already, I urge you to read my review of GE's proxy statement. This article is a follow-up to the review and serves to show how important it is that shareowners demonstrate their dissatisfaction with "long-term" performance and try to effect change to the composition of GE's board of directors via proxy voting. In addition, I believe that GE is undervalued and I explain why below.

In GE's 2009 Annual Report, longtime director (and now presiding director) and head of the Compensation and Management Development Committees, Ralph Larsen, wrote a letter to shareholders declaring that GE is all about long-term value creation. He refers to the "long-term" ten times in his one-page letter (see page 23 at hyperlink), which should raise a flag in its own right and in hindsight was clearly more smoke and mirrors from a board that for more than a decade has failed to either properly steward the company or hold management accountable. Consider the following:

During the past ten years, April 19, 2002, to April 1, 2011, excluding dividends, shares of GE have declined 42%. GE's quarterly dividend per share at the start of the period was $0.18; today it's $0.17 after falling as low as $0.10 during the 2008/09 crash, prior to which it was $0.31. Compare that to:

  • Returns of 25% and 28% (excluding dividends) respectively for the often cited S&P 500 and Dow Jones benchmarks
  • United Technologies (UTX) +123%; quarterly dividend: $0.1225 --> $0.48
  • Honeywell (HON) +55%; quarterly dividend: $0.1875 --> $0.37
  • Siemens (SI) +52%; annual dividend: $0.85 --> $2.95
  • 3M (MMM) +43%; quarterly dividend: $0.31 --> $0.59

Now, consider that 11 of 16 directors at GE have a tenure of at least 10 years, which spans CEO and Chairman Jeff Immelt's tenure as boss. While it's true that Immelt inherited a GE which had flirted with a $60/share stock price in 2000, it has been one credibility damaging thing after the other on his and the directors' watches (most notably may be the broken promise not to cut the dividend; see my proxy review for others).

Even acknowledging that the stock market is volatile, no matter how you slice it GE is down at least 25% over the past decade. In fact, beside the post-2008 crash, it hasn't traded as low as it does today since 1997. This raises two questions.

First, assuming Immelt could remain CEO through 2020 (culminating in a 20-year term), can he deliver results that enhance corporate value such that common stockholders (among which include current employees, company retirees with not insignificant portions of their wealth in GE common, as well as others that may be holding in a retirement account or whose shares are held for such purposes by a fiduciary) will be rewarded with meaningful gains in principal value and dividend income?

Second, how does the board factor into the equation of holding management accountable for a dismal decade and a dearth of evidence suggesting the situation is improving? The "market" appears to be getting GE right in the sense that it does not "buy" GE's trumpeting of billions and billions of dollars of stock repurchases that hardly put a dent in the share count.

Furthermore, by my quick analysis, I estimate that the market is essentially ascribing no value to GE Capital. That's despite it earning over $6.5 billion in 2011 (14%-plus profit margin) and the much anticipated matter of when GE Capital can resume payment of a dividend to the parent. One can hope for a sizable special dividend (I did my best to have a proposal included in this year's proxy for consideration of one but was defeated by devious tactics at the hands of our board directors and GE's external legal counsel; that experience is a separate story!), but, again, it seems there will be yet another expansion or renewal of the share buyback program.

So while I think GE is currently undervalued by at least 15% and the market not only seems to be disregarding the earning power and accumulated cash of GE Capital, but it also appears that investors expect GE not to grow, could this not all be because Immelt (management) and the board have lost their credibility? Outside of GE's Home & Business Solutions segment, whose profits are small by comparison to core operating segments anyway, each segment had margins in excess of 15% in 2011.

Transportation has been the most volatile, with margins of between 9% and over 20% in the past five years, but otherwise 15% - 20% has been the range. If one were to argue that GE ought to be able to grow earnings at least at a compounding 3% (low-end global GDP growth rate) through 2020, GE could be around 40% undervalued today before factoring in the repayment of dividends from GE Capital to the parent and the forthcoming incremental increases to the common dividend. And should GE find more success in reducing share count, the upside ought to be even greater. Lastly, shareholders would likely also see a higher premium paid for GE shares were it firing on all cylinders.

It's obvious to me, unequivocally based on Seeking Alpha readers' comments, and it's also evident to investors and former employees I'm speaking to, that change is badly needed in GE's board. Ralph Larsen is among the directors I voted AGAINST. His claims of long-term value are dubious at best when reflecting on the past decade. And going forward, there are few assurances at this point that history won't rhyme. As head of the Compensation Committee, he in fact has rewarded short-term performance and even allowed for opportunistic options grants that contradict his letters to shareowners.

All GE shareowners deserve better. This could be the year that GE breaks out; who knows. Shareowners all want nothing more than change and renewed success at GE. Enough smoke and mirrors. GE is reporting Q1 earnings on Friday (4/20), and we could see another token dividend hike, but the real issue is when GE Capital begins repaying dividends to the parent, how the capital will be allocated and how well will shareowners be rewarded.

Disclosure: I am long GE.