Over a decade ago, one of the greatest CEO's of modern history transformed this company into one of the most admired industrial companies in the world. Executives from this company were highly sought after by other companies as their training, competitiveness and competency were welcomed at many lesser companies searching for premium executive leadership.
This diversified company would grow earnings steadily through a cycle, almost with Bernie Madoff-type consistency. Other conglomerates and industrial peers envied its consistency in earnings, its portfolio of businesses, and the higher valuation and stock performance.
For 30 years, up until 2008, the stock provided over 36% annualized returns! And even after factoring the Great Recession we’re coming out of, the stock returned over 13% annualized returns, much higher than the stock market’s single-digit returns over the same periods.
One of the Most Admired Companies in the World
The stock is General Electric (GE:NYSE) and the CEO was Jack Welch. It’s big, but cheap and unloved. The company has been an American icon for over 130 years and Jack Welch was the modern-day face for the company for so long. His hand-picked replacement is CEO Jeffrey Immelt, who has been doing just fine, all things considered, since taking over several years ago.
For years, while the global economy was generally booming, the company generated tremendous amounts of earnings and cash and its diversification of businesses was highly regarded.
With 2008 sales of $18 billion, the multi-industrial company makes everything: jet engines, water technologies, gas, wind and solar turbines, generators, healthcare equipment, computer accessories, oil and gas equipment, light bulbs, housewares, appliances, locomotive engines and fuel cell technology, to name a few. It also owns NBC television, along with many successful cable networks and Universal Movie Studios.
Almost 35% of General Electric’s revenues are generated through the service and replacement business, which adds to its revenue and earnings stability (a great core investment consideration to look for).
For decades, GE’s smooth and steady earnings had been “influenced” by the financing arm, where arguably revenues, proceeds and earnings could be managed. That caused a premium valuation and almost cult-like appreciation for the stock.
For most of the 1990s and 2000s, GE regularly carried a 20+ price/earnings multiple, several points higher than the market as investors loved the consistency. Just look at its business mix. Back then, no one minded the increasing size of its financing business, because times were groovy.
Impact of the Great Recession
But the Great Recession exposed General Electric’s capital financing arm, which was generating close to 40% of its earnings! Financing, leasing and loans in all segments of the economy were the key to consistency and out-performance for so long, but ultimately the cause of death. Now, don’t get me wrong. GE didn’t do anything worse than any other financing firm or bank except for being so large and broadly exposed to the worst of it. Investors fled as all of their end markets tanked and the financing business did the same.
The stock went from a high of $60 right before Sept. 11 in 2001 to a low of under $6 this past March. It has been in the low teens for months, but I believe it is set for a move.
Working Through GE’s (Capital) Problems
GE Capital is one of the world’s largest providers of consumer and commercial financing's, having the number one position in at least 10 key financing segments. The Capital Finance segment represents 37% of sales and 33% of profits despite the problems faced. GE’s finance units include Commercial Lending & Leasing, Real Estate, Consumer Finance, and Aviation and Energy Financial Services.
In the heat of this downturn, loan losses grew, capital coverage fell, liquidity dried up and all of General Electric’s businesses (non-financing included) suffered greatly. Despite the economic backdrop, the company has tried to provide liquidity to its customers while taking several steps to better capitalize itself. It has reduced its leverage, issued equity, sold off trouble assets, increased the capital coverage and deposit base, improved liquidity and run various stress tests to make sure the worst was behind the company.
The company says the commercial real estate segment is still challenging but that other areas of the financing business have at least stabilized and are more than adequately addressed internally. Many believe there is another shoe to drop in commercial real estate, and I tend to agree. But well-run companies like GE have had time and have taken major steps to mitigate and reduce the impending risk.
Lastly, its rating is no longer AAA but is comfortably at AA/AA+ with even better risk management controls. Also, you might remember when GE cut its dividend as additional means to conserve capital. GE management is well prepared, if indeed commercial real estate becomes a big problem. The world doesn’t believe that quite yet, presenting further potential upside leverage to our thesis.
General Electric’s Bright Future: Alternative Energy
General Electric is a key global player in solar technology, wind power, water and process technologies, and nuclear power plants. This business is over 20% of sales and profits and has the potential for high single-digit growth going forward. The wide scope of products offered ensures that GE is best positioned to take advantage of the future direction of alternative energy.
Pure play alternative stocks trade at very lofty multiples while GE’s $2 billion to $3 billion in sales to alternative energy is trading at 10-12 times earnings. I can envision GE spinning out some of these attractive alternative energy pieces if the market doesn’t recognize its potential a few years down the road as the global picture somehow finds normalcy. If that happens, then it would be worth a few extra dollars in the stock price.
Bonus: General Electric’s Healthcare Exposure
One of GE’s other gems is its Healthcare business, which falls under its Technology Infrastructure segment. GE’s Healthcare business, roughly $2 billion in sales, makes and services a variety of medical imaging products, including X-ray, digital mammography, computed tomography, magnetic resonance and molecular imaging technologies.
These products are skewed toward diagnosis and prevention, which should be emphasized in any healthcare reform bill that might get passed. Long term, this business will grow revenues at a high single-digit rate! It’s a cheap way to add healthcare exposure to the Safe Haven portfolio.
Buffett’s Margin of Safety
In my opinion, there is not much downside in the stock given how depressed it is and where we are in the global recovery. Warren Buffett’s “margin of safety” for buying stocks applies here, essentially meaning that the valuation is cheap enough that downside risk is minimized, providing a so-called protection or “margin of safety.”
As an aside, speaking of Buffett, last fall Berkshire Hathaway purchased close to $3 billion preferred shares at a 10% rate, and warrants to purchase 135 million shares. So once again we’re investing with Warren Buffett — a good thing.
As mentioned above, the Financing problems aren’t completely removed but the company has done everything to cover any further losses and its prudence is to be commended. If the stock were to go under $10 again, I would be screaming “buy,” unless there was a serious issue that unfolded. Buffett’s margin of safety is quite large with General Electric, especially if you back out GE Capital.
On the other side of the coin, the upside is significant. By now you know that I try to be a step ahead of Wall Street — a little contrarian approach you could say. The stock has moved nicely off its bottom (along with the rest of the market), but at least now we have better visibility into GE Capital’s problems and economic outlook.
Wall Street hasn’t turned bullish yet, which will be great for the stock. Earlier this month, JP Morgan upgraded GE to a Buy and the stock moved up close to 5% that day. Similarly to other depressed industrial picks, when Wall Street changes sentiment, hopefully you already own the stock — otherwise you’re late to the party. Right now, the table below from First Call shows that 11 out of 15 analysts have yet to put a BUY on the stock. When that happens, look out!
Hitting High Price Target Means 70% Upside
If General Electric earns more than the $1.20 analyst consensus in 2011, as I expect it will, then the stock should hit price/earnings multiple.
That’s approaching a double in 16 months. So while I actually think $1.20 in EPS is a little conservative for 2011, GE can hit $20 by the springtime as the world improves, investor sentiment shifts, and global infrastructure spending kicks in. Don’t forget the 2.7% yield to provide some support.
Action to take: Consider General Electric (GE:NYSE) for your portfolio.
No comments:
Post a Comment