In our earlier thesis on General Electric (GE), we mentioned that it is a story of growing incremental margins, especially in its industrial wing, which comprises of aviation, healthcare, transportation, energy and Oil and Gas. We also mentioned how strongly GE Capital, its financial wing, has recovered from the financial crisis, and has started to pay dividends after a break of three years.
Although the stock is up 26% YTD, a lot of bottom line growth is still expected to come GE's way, which will help the stock price climb.
We say this because:
Organic Sales Growth:
GE is set to achieve faster organic sales growth than its peers because of a sharp increase in its Research and Development spending, and because of its wide product portfolio. The average organic sales growth rate of 16 industrial stocks, including United Technologies (UTX), Honeywell International (HON), Valmont Industries (VMI) and Dover Corp (DOV), for the quarters ending March and June turned out to be 7% and 4%, respectively. GE is expected to grow more than that. The growth story is linked to three of its industrial segments - Aerospace, Power and Water, and Oil and Gas, which collectively account for 60% of its industrial revenues.
Aviation expects a growth higher than 10% through 2014, as GE claims that 44% of its fleet has yet to see its first stop visit. As the spare part demand rises, which it does after engines are more than 5 years old, GE is expected to benefit from it.
In Power & Water, the company is making its market share grow. This has become possible after GE smartly allocated capital to the right areas. For example, GE has vigorously invested in gas turbines. Also, GE has turned its attention away from the solar business, which is expected to bode well for its margins. Partnership with XD Electric, a Chinese-based company, has helped GE to enter the HV power grid market. Although the market share is currently low, it is expected to increase with the passage of time.
In the Oil and Gas segment, GE has been able to make successful deals in the form of installing sub-sea systems at Julimar and an LNG project at Ichthys, which will provide growth to GE in the future.
Wind and Healthcare remain potential risks for 2013, but sensitivity analysis shows that a decline in these businesses will hardly affect the industrial sales growth rate. (10% drop in wind sales will bring a decline of only 80 bps in industrial sales growth rate.)
Massive margin improvement potential:
Although we have been emphasizing the fact that incremental margins for the industrial segments are on a rise, there are, still, a lot of areas where GE can work to improve its margins. One of these areas is the cutting down of costs, which GE plans to do. The recent removal of management in the Energy and Infrastructure department is expected to save the company $200-300 million a year. GE has a target of reducing operating expenses by $2 billion over the next two years that will add 120 bps to the overall margins.
Solid Dividend yield:
GE's 3% dividend yield is one of the highest among the sector. In fact, it is only lower than that of Emerson Electric Co (EMR). One of the dogs of Dow, this company is on its way to experience a double digit growth rate in 2013. The company's financing arm has also resumed paying dividends.
GE has kept a disciplined approach with regards to capital allocation, as already mentioned. It has been a combination of dividend payouts, share repurchases, and mergers and acquisitions (we have already covered the GE going big in mining segment).
The cash profile has been impressive. Cash flows are positive. Debt is not a cause for concern for the company. The following shows the growth story of the company over the last couple of years:
Given the impressive growth prospects, expected margin expansion in future and a solid dividend yield, the stock is recommended as a buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.