The Long Case for GE 9 comments
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Summary: General Electric (GE) appears to be a good buy—for both price and dividend growth—at its current price of around $28.
Type of Company and Stock: GE is a conglomerate, and its participation in several very different industries makes it almost impossible to categorize into my usual Type A, B, or D classifications. If I had to pick, I'd call it an A-B company. Morningstar places GE in its Large Value style box, describes its industry as Diversified Industrial Materials, and its type as Classic Growth. As we will see, these categories do not begin to truly describe GE's breadth.
Story and Strategy: Often misclassified as an industrial company, GE is actually a widely diversified conglomerate. GE is participating in several megatrends, including Healthcare, Globalization, Need for Infrastructure, and Security. It famously strives to be either first or second in every business in which it operates.
In recent years it has had six business segments: Infrastructure; Industrial; Healthcare; NBC Universal; Commercial Finance; and Money. In late July, GE announced that it will reorganize some of those segments into four business units to hone its focus on its most promising growth opportunities. The new units are:
- GE Technology Infrastructure, which includes healthcare, aviation, transportation, and enterprise solutions
- GE Infrastructure, which will include energy, oil and gas, and water
- GE Capital, which brings together all of the company's financial-services businesses, including commercial finance and GE Money (banking and credit services)
- NBC Universal, which remains unchanged.
GE's products and services range widely. Some are related and synergistic, while others are totally unrelated. Examples of GE's products include gas turbines; medical imaging systems; other health-care products; jet engines; locomotives; water-filtration systems; TV and movies (through NBC/Universal); consumer and commercial lending and financial services; equipment leasing; airport security scanners; and various other consumer and industrial products. GE expects to pull in over $110B in 2008 revenue, making it one of the largest companies in the world. GE's huge size enables it to invest almost as it pleases in growing businesses and to overcome virtually any barrier to entering a new market.
With such power comes a need for discipline, and GE has displayed that for decades. The principal strengths that GE brings to the table are proven excellence in (1) allocating capital, (2) operating efficiently and effectively, and (3) re-inventing itself to take advantage of opportunities presented by the constantly changing global marketplace.
While GE's business segments are sometimes unrelated, within segments GE is adept at integrating businesses with strong synergies and opportunities for information-sharing across business lines. GE says it aims to deploy capital "to areas which will generate strong sustainable long-term growth and returns." The company has long been intelligently balancing acquisitions, divestitures, share buybacks, dividends, internal growth investments, internal efficiency investments, and global diversification. Almost as important as GE's ability to allocate capital is its proven ability to squeeze out unnecessary costs, achieving operating efficiencies that generate healthy returns on invested capital.
GE was the top scoring company in Fortune's 2007 list of Most Admired Companies, but it dropped back somewhat in 2008 (while still maintaining a high rating). GE's efficient and effective corporate culture extends back decades. The company is the only remaining original member of the original Dow Jones Industrial Average (1896). GE's Infrastructure segment is currently its most successful, the result of several years of attention to strategic divestitures, acquisitions, and restructurings designed to focus on the growing global demand for infrastructure. It has put together an attractive menu of solutions.
Infrastructure is enjoying fast rates of growth, thanks to industrialization and urbanization in emerging markets. This business, which supplies (and later maintains) differentiated, high-margin, market-leading products includes jet engines for military jets and commercial airliners; turbines for electric power plants; and equipment for generating wind power. These businesses are delivering sizable revenue and enjoy double-digit growth rates. The company is constantly re-positioning itself as it seeks to enter (or remain in) only fast-growing and high-margin businesses, as well as make itself less cyclical.
Some recent examples:
- Last year, GE offloaded its underperforming plastics business, selling it to a Saudi Arabian company for $11.6 billion.
- In May, GE announced plans to spin off or sell its century-old home appliance business. When it found no serious takers, it announced in July that it would spin off the entire business unit, expected to take place in early 2009.
- Japan's Shinsei Bank is buying GE Money's Japanese consumer finance unit, which includes personal lending, credit cards, and mortgage lending.
- GE has announced plans to invest $2B in China as part of a strategy to double revenues from that country in the next 3 years.
- In July, it announced an $8 billion joint venture (financed 50-50) with Abu Dhabi-based Mubadala Development Company. The partnership will focus on commercial finance in the Middle East and Africa, areas expected to display continued strong growth over the next several years. This venture brings in $4B in outside financing; plays well into GE's strategic infrastructure focus; helps GE extend its presence in emerging markets with a proven partner; and creates a relationship with a leading player in one of the world's top growing markets – the Middle East.
- GE edged out Pratt & Whitney and Rolls Royce for Boeing's BA next-generation fleet by offering a less fuel-intensive engine.
CEO Jeff Immelt replaced the legendary Jack Welch seven years ago. The stock's price is lower now than it was then—suggesting that there was most definitely a "Welch premium" in the price. 
Under Immelt, GE is staking more and more of its future on the global infrastructure build-out, as well as on developed countries searching for energy efficiencies. These markets have generated double-digit growth in the past few years and show no signs of weakening. The company grew its order backlog by over 42% to more than $19 B in Q2.
It has been estimated that there is $40 Trillion worth of infrastructure projects that need to be done around the world. Beyond infrastructure, half of GE's profits come from GE Capital Services, which manages roughly $700 billion in assets. (That is why calling GE an "industrial products" company is so misleading.) This huge financial operation has been hit and hurt by the worldwide credit crisis, contributing to the stock's downfall beginning last October.
Financials: GE's Infrastructure and Industrial operations provide about 60% of revenue, the others 40% combined. International markets generate 60% of revenues. GE has a presence in more than 100 countries. As a huge corporation, GE is subject to the law of large numbers, meaning that there are practical limits on its growth capabilities.
That said, the company has achieved solid earnings growth over the years with cost-cutting, productivity improvements, and by allocating capital well (including strategic acquisitions and divestitures). It enjoys a rare AAA credit rating, which enables it to earn higher spreads on loans to customers. The company's stated goal is to increase revenues by 2-3 times GDP.
Its revenue growth rate over the past three years is 14%. Its earnings per share [EPS] growth rate over the past three years is 10%, and consensus analyst expectations are for a future (3-5 year) EPS growth rate of 11%. Its return on equity [ROE] is a solid 18%, and it has been above the 15% benchmark for many years.
GE has grown EPS in eight of the last nine years. GE carries a large and seemingly unnecessary debt load. Its debt-to-equity (D/E) ratio is 280%, far above the S&P's 110%.
In Q1 2008, GE reported very disappointing quarterly results, in fact its worst quarter in 5 years. There was a shock resulting from that, because GE had not missed earnings estimates in years. Contributing factors included the mark-to-market impact of the credit crisis on GE's financial segment, real estate deals that could not close because of the financial freeze, last-minute charge-offs in the finance business, and some weakness in the company's U.S. industrial results.
Q2 was better, as nearly flat earnings (year-over-year) were in line with management's guidance and general expectations. Revenue rose 11% to $46.9B. Non-U.S. growth was up 24% from last year, somewhat offset by a U.S. revenue decline of 4%. Infrastructure posted 26% top-line growth, 18% margins, and 24% earnings growth, with strong continuing demand foreseen globally.
Weakness was evident in the Consumer and Industrial segment, which, as noted earlier, GE intends to spin off. GE Money's profits fell 9% (versus consensus estimates for a drop of 15%-20%). GE affirmed its full year earnings forecast of $2.20-$2.30 per share (barely above 2007's EPS of $2.20). With plans to spin off its industrial and appliance units, and forecasting further lower profit from its finance segments, GE's earnings growth looks stagnant for 2008.
Long term, its repositioning and focus on infrastructure seem like good moves that will restore healthy growth rates. I use what I call the Easy-Rate™ system to score companies against each other based on their story, strategies, and financial performance. Under this stringent system, GE scores 36 points, which is in the "Very Good" portion of the scale (any score over 40 is considered "Excellent").
Dividends: In addition to its characteristics as a growth stock, GE is a reliable dividend stock. It has paid dividends since 1899 and increased them at more than 8% annually for 50 years. Its 3-year dividend growth rate is 12%, and its 2007 growth rate was about the same. 2008's dividend growth rate is not yet known, as GE historically raises dividends once per year, in the final quarter. GE's dividend payout ratio is a safe 52%. Overall, its dividend is not at risk, and an increase of 9% to 10% seems likely for 2008. Its current yield is unusually high at 4.3%.
Stock Performance and Valuation: Since October, 2007 through the middle of 2008, GE's stock has fallen about 33%. Besides the financial segment concerns, other contributing factors include the general bear market, GE's Q1 earnings miss, and perhaps uncertainties over the directions in which Immelt is taking the company. GE's total returns have underperformed the S&P 500 since 2005 despite its healthy dividend record. I use a model that blends six valuation ratios to place a composite valuation on a dividend-paying stock such as GE. Under this system, GE's valuation at a recent price of $28.27 rates "Good," meaning it is significantly undervalued.
Investment Thesis and Conclusion: I think that GE merits strong consideration as an advantageously valued, long-term price-growth and dividend-growth stock. Its business direction and strategies seem well thought out and are likely to restore healthy growth rates to this behemoth of a company. Global infrastructure, alternative energy, and emerging economies are great areas to be in long term, and GE is focusing its efforts there. Its valuation may be presenting a rare opportunity to acquire this iconic company at a very attractive price. And its dividend history is about as solid as they come, with no sign of abating any time soon. Its dividend is likely to rise in the fourth quarter.
Disclosure: Long
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This article has 9 comments:
I have written about (and been dead right about) why if you are looking to create wealth, you cannot and should not own any of the mega cap stocks in existence. If you are 55 and over, and want a stock that should not move much and give you an OK yield, and preserve your wealth, then GE and the mega cap stocks are for you.
GE, the stock, has gone nowhere in 10 years- 0% return. Inflation is greater than the dividend so the dividend argument does not hold water either.
GE, as with other mega cap stocks, cannot exponentially expand it's market cap, thanks to the laws of large numbers, amount of outstanding shares, etc.
It took GE 25 years to add 240 Billion in market cap from when it was a 10 billion dollar market cap company- a return of 1000's of percent.
If the stock was able to add that same amount in market cap today, you would get a return of 100%. If it took GE another 25 years (from today) to add another 250 Billion in market cap, you would have a 100% return over the next 25 years.
The simple (and it is simple) fact is that in order to create wealth over time, if you are anywhere between 20 and 55 yrs old, you need to be invested in companies that are small to mid cap companies, that have market caps any where from 800 million to 2 billion, with fewer than 200 million shares outstanding.
What would you rather own: A 1 billion dollar market cap company, that if it expanded its market cap to 11 billion over 25 years, thus resulting in a 1000% return (and the possibility for another 1000% return over the next 25 years)
OR
A 250 billion dollar market cap company that maybe has the potential to rise about 100% over the next 25 years. Not because the company is a poor company, no, simply because mathematically, the odds are against you.
XOM was the exception because of oil prices, however if oil settles into a huge trading range between $90 and $150 over the next decade, I expect XOM to return very little over that time frame.
Full disclosure- I have no GE position, in any market.
Not mentioned that GE has invested in oil service related companies via their Vetco Gray and Sondex acquisitions. Vetco Gray is very tied into subsea drilling although there are more focused ways to play that segment.
That is the way to play it. GE is not and should not be considered an investment.
The mega cap stocks are meant to be traded (just like the big boys do, though don't tell that to the sheeple general public who have no idea just how manipulated these big stocks are)
MM's love when the general public are "investing" in GE. The MM's make a mint skimming the little guy 24/7.
Thank you for proving my point. I know you didnt mean to...LOL
I love when people talk about "past" returns and gloat as if they assume the future is going to be the same. How have your returns been since 1998?
Oh thats right, ZERO PERCENT.
It is so comical so see the same wording that others have used over the past 10 years
< SO m'frens, soften you views and smell the success-GE's next 10 years look spectacular, I highly recommend the stock anywhere under $40 per share-start collecting it now, leave it alone + dividend re-invest your dividends for 10 years, and reap the rewards. This is the safest investment in a world class company you will ever make, guaranteed!>>
Is that the same guarantee that shareholders have had over the past 10 years?
It is typical to see current shareholders (pre 1998) who always defend the company they are "in love" with. Ofcourse, and why not? They have 1000's of percent return already (see "in the past") so they just assume the good times and more 1000% returns are ahead of them.
See you in anther decade, where if you are lucky, GE returns maybe 30% over that time.