GE: You Can Smell The Blood
- Keep an eye on the correlation between GE, other industrials, and the Japanese Yen.
- We are at a point in the business cycle where a stock with a beta as high as GE's cannot be ignored.
- That is true particularly considering GE is the most attractive restructuring story of a certain size in the marketplace.
- Of all industrials, though, Cummins remains the most attractive equity story, based on its risk/reward profile.
With the Japanese Yen strengthening against the US Dollar, you have to wonder where your money is safely parked nowadays. Could the answer be General Electric (NYSE:GE)?
And, are there any useful lessons to be learned by gauging the value of the Boston-based behemoth against the USD/JPY exchange rate?
(GE vs USD/JPY, 4 Feb - 9 March. Source Yahoo Finance)
Solid, high-yielding consumer staples — Coca-Cola (KO), PepsiCo (PEP), Procter & Gamble (PG), Johnson & Johnson (JNJ), and so forth — remain riskier, in terms of capital appreciation, than they ought to be at mid/late cycle after a nine-year rally, while more cyclical equity investments, such as industrial stocks, look so overvalued based on my DCF calculations that only a very long-term view might attract value hunters now to such terrific companies such as Boeing (BA), Caterpillar (CAT), Cummins (CMI), Honeywell (HON) and United Technologies (UTX).
(GE vs JPY vs 10-yr US Trs vs BA vs CAT vs CMI vs HON vs UTX. Source: Yahoo Finance)
Very possibly, GE is the most attractive restructuring story of a certain size in the industrial world, and that is reflected in its depressed share price. The stock currently trades at $14.5, which is close to multi-year lows, having changed hands at much higher levels for most of the past two years.
(Source: General Electric)
However, GE has been more resilient than many pundits thought it would be in the past two weeks since its 10-K hit the wires on 23 February.
(GE vs S&P 500 vs 10-yr US Trs vs BA vs CMI.)
What does that mean?
The 10-K announcement essentially was a non-event for those who have followed its developments over the years, but nonetheless its resilience on the stock exchange has been remarkable in a market where willing risk-takers were punished and where only the S&P 500 Index and the USD/JPY have fared better than GE once HON, CAT, UTX, Siemens (OTCPK:SIEGY) and ABB (ABB) and several other similarly risky stocks are included in the chart above for comparable purposes.
So, I am increasingly inclined to suggest that GE should trade at a larger premium than 3.3% ($12.5) to my estimate of liquidation value ($12.1), and while the $14 trading area doesn't represent "bargain territory", it could make sense to open a 1:4 position around these levels.
Say you have $100 of spare capital to allocate to one specific stock/bond you really want to buy today, you invest $25.
Counterintuitively, fleeing risky assets might be the wrong thing to do because it is the beta and the quality of earnings that matter in any investment considerations now, as well as core cash flow expectations. GE's earnings quality is not that attractive, I admit, but how about its projected operating cash flows, which were very weak in the first half of 2017 when expectations were very high?
There might be some upside in this respect, I reckon. Managers have already dampened cash flow expectations for the first half of 2018, and the "catalyst" is the quarterly update due on 20 April. And then, a relatively high beta is a plus.
(Here is the beta of equity investments that are on my watch list: CMI 1.2; BA 1.4; CAT 1.2; HON 0.96; EMR 1.1; ROK 1.2; WMT 0.57; KMB 0.7; PEP 0.7; UPS 1.05; AT&T 0.4; BTI 1.4; MO 0.6; and PM 0.9, all sourced from the Financial Times.)
Seriously Worth A Look?
We are at mid/late cycle and GE could be one of those investments seriously worth a look, its allure stemming from a restructuring story that has now become more appealing than previously, mainly due to a share price that trades close to liquidation value as measured by the value per share of its most liquid assets, but where its most liquid assets could be worth substantially more if the right actions are put in place. This is how good working capital stories usually play out, and could be highly remunerative.
Meanwhile, with the press talking of a currency war as being just around the corner -- that is the environment we have lived in for a decade -- a pure top-down approach that excludes possible considerations about fundamentals, on a preliminary basis, points to a couple of elements that are surely worth our attention.
Look at the two-year chart below and consider the trends before the Japanese Yen (USD/JPY) and GE diverged.
(GE vs JPY. Source Yahoo Finance)
Their five-year performances are shown below.
(GE vs JPY. Source Yahoo Finance)
The release of first-quarter numbers in 2017 was when it all started for GE, and it's possible that management have learned the lesson in the past few quarters. I am doubtful just as you are perhaps, but then now consider the long-term trends for GE and the Japanese Yen since this stock market rally started nine year ago.
(GE vs JPY. Source Yahoo Finance)
From a pure trading perspective, GE could be an obvious buy here if we assume the exchange rate (the Japanese Yen is a safe haven, by definition) is close to bottoming -- which, of course, may or may not be the case.
(GE vs JPY vs 10yr US Trs. Source: Yahoo Finance)
GE Vs CMI... $14 vs $140
Rising interest rates from these levels stateside could easily contribute to the strengthening of the Japanese Yen, but similarly they could benefit higher beta investments until recession hits next year or later. My worst-case scenario remains for a technical recession that could materialize in the third quarter of this year, although recession risk probability has fallen to 4% from 27% in the past two calendar quarters. The flattening of the yield curve has become less of a problem these days, apparently.
Based on a scenario according to which 10-year US Treasury rates rise well above 3% by the end of the second quarter and the USD/JPY hovers around these levels (-5%, floor) in the first half, of all the aforementioned stocks... guess what? Cummins is the best pick.
Its shares hover around $159, and CMI is only between 5% and 9% away from bargain territory, according to my calculations. Based on cash flow multiples, CMI would be a fantastic opportunity around $140 not only for DGI investors but also for value hunters after growth at a reasonable price. Although, quite frankly, it looks fairly valued already.
Of course, it is never wise to invest in any stocks without paying attention to fundamentals, and the upside with GE remains far greater -- on this matter, I am crunching the numbers, but I have been reluctant to change my personal price target of $12.5 (my fair value estimates are now under review).
If you have followed my coverage, you should not be surprised to hear I am still not buying into this restructuring story, given the action of its long-term bonds in the secondary market:
But an upgrade to $14.7 is surely possible ahead of first-quarter results -- as I mentioned previously, that level would imply 14.9% downside and 22.4% upside against my current fair value estimates.
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