I have to be honest. I don't like to invest in conglomerates. My issue with them is it's too infrequent to see every one of their business components firing on all cylinders. Often, three businesses will be great and two will be struggling. I prefer clean plays, where the company does one thing, does it well, and dominates the sector. However, I recently did some research into General Electric (GE) and became intrigued enough that if the stock were to fall under $20.00 I would buy it.
General Electric is one of the most well-known companies in the world, founded in 1892 when Thomas Edison's Edison Electric Company merged with the Thomas Houston Electric Company. GE has been a fixture in people's lives for over 100 years.
Currently, GE is a large conglomerate with business interests in many different areas, including a financial arm of the company that suffered along with other financial companies during the banking crisis of 2008/2009. The financial component of the business had become such a large component of GE that during the financial meltdown, GE needed a bailout from the government and a cash infusion from Warren Buffett to stay afloat. Since that time CEO Jeffrey Immelt has tried to reduce the size of GE's financial business while building up the infrastructure businesses. Although it has taken some time, it appears to me, that his vision is starting to pay rewards.
Aviation - GE aviation is a $19 billion business which is comprised of commercial engines, commercial engine systems, military engines and services, and aviation systems. GE is the largest provider of jet engines in the world, having grown the business from 14,000 engines in 2000 to 30,000 today. They have designed next generation engines with the GEnx being put in to service and the LEAP and GE9X on the way. GE also provides avionics as well as power systems for aircraft.
Aviation is a growing business. GE expects to have 35,000 engines in use in 2015 and 46,000 in 2020. The more engines in flight, the more engines that need service, GE forecasts double digit growth in the aviation business as well as margin expansion. Although GE is the clear leader in aviation, they do face competition from other companies like Rolls Royce, Pratt & Whitney (which is part of United Technologies (UTX)), and others. It should also be noted that although they do see growth in the military aviation business they expect the growth to be slower.
Oil and Gas - GE has made a number of acquisitions in the oil & gas business to grow the business from $4 billion in 2004 to over $16 billion today, with more growth to come. GE makes various parts for the drilling business, such as pressure and temperature monitors, leak detection, blow-off preventers, robotic radiology, compressors, mud pumps, etc. They are also very big in LNG and see that as a very fast growing business. Like aviation, after-market services are a big and getting bigger business, with GE again seeing strong growth.
GE forecasts margin improvement, increasing sales, and double digit earnings growth in 2012 and beyond for their oil and gas business.
Healthcare - GE claims to be the leading healthcare solutions provider in the world and they very well may be. Healthcare is an $18 billion business and with the population aging and obesity on the rise the healthcare segment will continue to grow. GE is the leader in ultrasound, molecular imaging, life sciences, CT scans, and healthcare software. Healthcare, as with most of GE's businesses, is an international business and they have seen slowing sales in Europe. The slowing sales in Europe have been offset by growing sales in China and other emerging markets.
GE forecasts steady earnings growth for years to come.
Energy Management - The energy management business includes grid automation, metering, distribution & protection, power conversion, and electrical propulsion. Their energy management business is used by utilities, oil and gas companies, marine companies (propulsion), and in industrial and commercial facilities. At present, due to a large amount of competition, margins in the business are thin with an operating profit of just 2%. However GE forecasts margins expansion in the future.
The power management business is a competitive market with companies like Siemens (SI) and Eaton (ETN) fighting for business. GE forecasts single digit annual growth through 2015.
Home and Business Solutions (H&BS) - This segment of GE has been slow ever since 2008, when housing starts collapsed. However, GE has not been standing still as they have updated their product line launching new water heaters, refrigerators, dishwashers, top-load washers, and dishwashers. The home solutions division is tied to the housing recovery, the more new homes are built the more GE appliances may be installed. GE believes they can grow share and margins in the appliance business by 1% in 2012.
Lighting has been a GE mainstay for many years, but the lighting environment today is difficult. With incandescent bulbs being phased out and rare earth costs rising 2,000% since 2010 the costs in the business have been rising. LED's are seen as an opportunity, but the best GE can say about the overall lighting business is that they are managing in a tough environment
Overall the H&BS arm of the business has been soft and the forecast is cautionary.
Transportation - GE is the leading diesel locomotive manufacturer and also is involved in diesel engines, diagnostics, fuel efficiency, and has a growing business in mining vehicles. The train business is expanding as the fuel efficiency offered by locomotives is driving freight hauling to the rails. GE has developed the next generation locomotive, the Tier 4, which reduces emissions by 75% and meets all upcoming EPA regulations. The train business is an international business with sales in countries as far away as Kazakhstan. The newest technology for trains GE is working on is LNG powered trains, which would reduce fuel cost for the rail companies while also reducing emissions.
Using their battery and propulsion expertise GE has grown their business in mining by building underground vehicles like battery powered haulers and diesel powered scoops. GE sees making some niche acquisitions in this business and forecasts continued growth.
Power And Water - GE is the world's leading gas turbine manufacturer and is responsible for approximately 25% of the world's natural gas generated electricity generation. With gas prices low in the United Sates, utilities have been switching to natural gas turbines and GE has been the big winner. Gas turbines are also becoming more popular in countries like Russia and Saudi Arabia.
Whereas the gas turbine business is booming, GE sees the wind turbine business slowing as a "Production Tax Credit" for wind is set to expire this year, which GE believes will slow sales. GE will attempt to manage around the slow-down and still sees some positives in the wind business such as services. However, all you really need to know about wind was summed up by Jeffrey Immelt at a recent investor conference, "Wind is going to be a negative."
GE is also active in the water reuse business, with products such as water evaporators and ultrafiltration to capture, clean, and reuse industrial water.
Overall, GE sees operating profit in the power and water business remaining essentially flat to very low growth.
GE Capital - Basically the lending arm of GE providing loans, operating leases, financing programs, equipment leasing, and other financial support to corporations. For years GE Capital was GE's shining light, producing loads of cash and profit until 2008, when all that changed. Since then, CEO Jeffrey Immelt has been working to reduce GE Capital's influence on the company's bottom line with a goal of reducing GE Capital to 30% to 40% of the earnings. GE Capital has recently seen improved performance, in the most recent second quarter GE Capital paid a dividend of $3 billion to the parent company. Much of the improvement is in real estate as GE saw improvement in global real estate valuations, with a $280 million profit in Real Estate for the first six months of 2012. (GE Capital performance information can be found here.)
NBC/Universal (NBCU) - GE has minority ownership (49%) of NBCU, Comcast (CMCSA) owns the other 51%.
A Lot to Like
As I researched GE, I found myself constantly thinking that they are in some real good businesses. There is no doubt that healthcare, energy, aviation, transportation, and energy management are growing businesses, all of which GE is well-positioned in.
Many of the products they sell require service and their service business is a high margin business.
The company throws off a lot of cash and intends to use the cash for dividends, share buybacks, and niche acquisitions. They are not looking for any large acquisitions.
It appears GE Capital is on solid footing and has begun to create cash for the parent company.
If housing improves in the United States the appliance business will improve.
To GE's credit they have invested in all their businesses and have developed leading products.
Management forecasts double digit earnings growth the next two years.
Not Everything is Rosy
I prefer companies with wide moats and GE has no moat. In almost every business they compete in, they have major competitors with pockets as deep as GE. In transportation, it's the likes of Caterpillar (CAT), in healthcare it is Siemens, Philips, Toshiba and others, in oil and gas it is Flowserve (FLS), Dresser-Rand (DRC) and others. Competition keeps margins down, which in turn keeps profit down. In several of GE's businesses, like power management, GE management stated margins were under pressure.
Europe is slow. During the second quarter earnings conference call, Immelt stated Europe was tough, especially in aviation and healthcare. Europe is a big part of GE's business and with austerity the word throughout Europe, I don't see that changing.
GE has over 10 billion shares outstanding, which is more than any company I can think of. With that many shares outstanding, earnings per share growth becomes difficult. To GE's credit, they do intend to buy back shares in an attempt to get the share count down.
As with all conglomerates, GE has a couple of divisions that are struggling: appliances, lighting and wind are all struggling and the military portion of the aviation business could be less than robust if U.S. budget cuts reduce defense spending.
GE Capital is still the largest share of the company's profit, currently at around 40%. Although improving the GE capital still has issues they are trying to work out and the earnings from this sector of the company could fluctuate.
Although I found much to like in GE, I have enough doubt about the company not to feel compelled to buy it today. At a price just under $23.00, GE trades at approximately 20 times earnings, which is a reasonable valuation for a company projecting double digit earnings growth the next two years. The yield at 2.9% is not overly generous, but with GE's hefty free cash flow I am sure dividend increases are forthcoming.
The consensus forecast for 2012 per share earnings is $1.56. Put an 18 multiple on that and you get a price of $28.08. Consensus forecast for 2013 per share earnings is $1.74; an 18 multiple would put the price at $31.32. So it is clear to me there is upside to the stock. I used an 18 multiple as that is more in-line with the industry average than the 20 P/E GE currently has. (Consensus earnings forecast found here)
If the stock price were to fall under $20.00 I would seriously consider buying it, assuming the business was still operating well. This would not be a stock I would hold forever as it is greatly tied to world economic activity and any world slowdown would have a large effect on GE's earnings. GE appears to have some momentum in their business operations, catching the upward momentum could prove profitable for investors.