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Our analysis shows that General Electric (NYSE:GE) stock can provide both capital appreciation and current income in the form of high dividends. The company is diversified into various industries with a strong balance sheet and improving margins, with a reasonable upside potential.

Summary

  • Improving margins. Energy infrastructure revenues increased 18% in the first quarter of 2012 mainly due to increased equipment sales. Under a contract of $150 million with Petronas LNG complex, GE will provide the company with turbo compression technology, which will enhance its production capacity. Healthcare revenues are also improving as demand for medical equipment increases, both in the U.S. and Asia.
  • EPS of $0.34, up 3% from $0.33 in the first quarter of last year. Earnings have shown an impressive growth, and the trend is expected to continue with a strong demand for its industrial products in emerging economies.
  • High dividend yield. Dividend yield, currently at 3.60%, makes GE a valuable investment compared to treasuries.

The Company Description:

General Electric is a multinational conglomerate that produces various industrial products as well as consumer appliances. Its operations also span healthcare, energy and financial services.

Stock Price Drivers:

  • High demand for specialized technologies in various industries (energy, healthcare).
  • Rising costs for oil and gas exploration, demanding better and more efficient technology.

Upcoming catalysts:

  • A quarterly dividend of $475 million, payable to GE by GECC. Also, a special dividend of $4.5 billion, payable to GE, which was suspended in 2009.
  • Acceleration in a share repurchase plan in 2012.
  • Rising costs for oil and gas exploration, demanding better and more efficient technology.
  • Emerging markets providing an opportunity for growth, especially for the healthcare division.
  • GE is in talks to provide equipment for Malaysia's LNG project.

Bullish Thesis

GE is a high dividend stock, currently yielding 3.60%. Not only is that significantly higher than its peers, but it also provides value when treasury yields are this depressed. Both gross and operating margins are higher relative to its peers and high growth in earnings is expected, with GE aggressively bidding for projects internationally. A consistent earnings growth may lead to a high price-to-earnings multiple for the company, which is currently at a discount to its industry average, thus improving its valuation. Based on a price-to-earnings multiple of 15x and an expected bullish EPS of $1.75, we expect the TP to be $25 with an upside potential of 25%.

Bearish Case

After a downgrade of the GE and GECC debt rating by Moody's, it may become difficult for the financial wing of the company to raise funds through debt issue, which can disrupt GE's operations. Lower demand for GE's debt, coupled with higher return requirement from potential debt investors will adversely affect the company's liquidity and capital requirements, and thus the bottom line. Because of the company's conglomerate structure, it also faces integration problems and is struggling with various acquisitions it has made over the years. Moreover, rising pension benefits may also reduce GE's earnings since its pension plan is underfunded.

Competitive advantage

GE's diversification in operations hedges the company against sectors performing poorly, as their financial results tend to get smoothed by the sectors performing well. It has been able to buy and sell various companies to benefit from favorable market conditions. However, GE has also been criticized for its conglomerate structure and lack of focus.

GE generates most of its revenues from energy infrastructure and financial services division, GE energy and GE capital. The energy infrastructure roughly represents 45% of the company's industrial revenues. GE capital provides lending and leasing services to various small and mid-sized companies across various industries and geographies. The financial needs of the group are met by GE capital, which raises liquidity from the issuance of loans, commercial paper in the public and private markets, as well as receivables.

Comparison with S&P 500 and major conglomerates

GE's YTD stock performance

Source: Google.com/finance

Financial Performance:

Despite revenues taking a hit, GE's gross margins improved compared to last year. Energy infrastructure revenues increased 18% in the first quarter of 2012 mainly due to increased equipment sales. Under a contract of $150 million with Petronas LNG complex, GE will provide the company with turbo compression technology, which will enhance its production capacity. GE reported a Q1 operating EPS of $0.34, up 3% from $0.33 in the first quarter of last year. Earnings have shown an impressive growth and the trend is expected to continue with a strong demand for its industrial products in emerging economies. The company has a strong balance sheet, but is highly leveraged. It has maintained a stable payout ratio of approximately 50%, which is relatively higher than its competitors.

Conclusion: GE stock can provide both capital appreciation and current income in the form of high dividends. The company is diversified into various industries with a strong balance sheet and improving margins, with a reasonable upside potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: General Electric: Dividend Dog Has 25% Capital Appreciation Potential