Over the years, General Electric (GE) has turned into a bit of a financial company. Approximately 31% of business came from GE Capital in 2011 - nominally more than Energy Infrastructure's contribution. Moreover, aviation & healthcare represented a combined 25.1% of the business in 2011. In my view, one segment that has not gotten enough attention is the aviation segment. This line has grown from being less than 10% of business in 2007 to being 12.8% in 2011. Since GE is a conglomerate, it makes sense to value it by its parts.
One way to value GE's aviation business is to compare it to peer companies Honeywell (HON) and United Technologies (UTX). On a multiples basis, GE is cheaper than Honeywell but more expensive than United. Overall, the conglomerate trades at a respective 17.1x and 12.2x past and forward earnings with a 3.3% dividend yield. The Street currently rates the firm a "buy", but the $22.50 price target is not at a meaningful premium to the current business.
Note: GE's EPS over the past decade.
The limited margin of safety to the price target is complicated by unpredictable earnings. Accordingly, GE is 56% more volatile than the broader market. I actually find that the amount of risk that has been factored into the stock has irrationally discounted the solid fundamentals. GE has a solid brand, stable moat, and plenty of room to penetrate in emerging markets. EPS is expected to hit $1.71 next year and grow 12.4% annually over the next 5 years. That means 2016 EPS of $3.07. At a 17x multiple, the future value of the stock will be $52.15. Discounting backwards by a WACC of 10% yields a fair value figure of $32.38, which implies nearly a 60% margin of safety. The market seems to be factoring in a discount rate that is north of 20% - absurd given the strength of GE's brand and commitment to returning free cash flow to shareholders.
In this bullish backdrop for GE, United and Honeywell will be positively correlated. The Street anticipates a similar ~12.5% EPS growth for United and Honeywell and rates all 3 a "buy" or better. United is a more attractive pick than Honeywell given its much lower multiples for similar growth prospects. MSN Money's StockScouter rates the firm a 7 out of 10 and this optimism is backed by excellent performance. In the first quarter, United beat expectations by an impressive 26.7%, which carried forward momentum from the preceding solid five quarters. By contrast, Honeywell only beat expectations by 5.1% in the first quarter. Despite excellent performance by both performance and better performance by United, United fell 8.9% while Honeywell fell 8.5%. I believe that much of the shareholder value loss stems from growing pessimism over the macroeconomy and defense budget.
Combined with excellent fundamentals, these aerospace and technology firms are well positioned to generate high risk-adjusted returns when bearish scenarios fail to materialize. Employment figures, while far from strong, have improved. In terms of spending cuts, I anticipate entitlements seeing most of the reductions over the long-term. Defense has actually fallen as a percent of the US budget while entitlements have soared comparatively. The current rate of entitlement growth, unlike defense programs, is far from sustainable and efficient. In short, defense will be cut, but not to the extent that the market expects. Moreover, firms like United, Honeywell, and GE have excellent fundamentals / diversification to weather macro storms.
Author's note: all ratings are sourced from FINVIZ.com.
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