Originally posted Saturday. Barron's just ungated their cover story, we're reposting for folks who don't subscribe (yet). It's a major piece.
After a decade of disappointment, General Electric is ready to revive. Why CEO Jeffrey Immelt could go from F student to the head of the class.
The stock market has scorned General Electric for much of the past decade, and the potentially catastrophic problems at the Fukushima Daiichi power plant's six nuclear reactors–all designed by the huge American conglomerate–certainly aren't a plus. But the concern is obscuring a reality: After years of underperforming, GE finally seems positioned for a strong comeback.
The Fairfield, Conn.-based company's shares (ticker: GE) have lost about 50% of their value over the past 10 years, versus a 14% gain for the S&P 500, and they've badly trailed those of GE's arch rivals, including United Technologies (UTX) and Siemens (SI).
To some investors, the disaster in Japan points toward a continuation of the losing skein. But despite its seriousness, it's likely to leave the company's operations and reputation largely undamaged. Although the plant's design has drawn fire from some critics, Nicholas Heymann, an analyst at Sterne Agee, notes that the four-decades-old reactors survived an earthquake that registered 9.0 on the Richter Scale, well above what the Japanese government's specifications demanded. "I don't think there's really an issue with regard to GE's reputation," says Heymann, who has a Neutral rating on GE. As for legal exposure, Deane Dray, an analyst at Citigroup Global Markets, noted recently that "equipment suppliers such as GE are not liable for financial damages, based on longstanding channeling laws which have been in effect since the early 1960s in multiple countries, including Japan."
At about $1 billion, nuclear power accounted for less than 1% of GE's $150.2 billion in revenue last year. In fact, gas and wind turbines produce roughly 40% of its nearly $31 billion in annual energy sales. If some countries pull back from nuclear power, other parts of GE's energy portfolio could benefit.
More important, most of the rest of the company's operations are improving, some quite sharply. In particular, GE Capital -- the unit that has produced the most anguish for shareholders in recent years -- is recovering from the excesses that seriously threatened it during the 2008-2009 financial crisis.
THAT'S GOOD NEWS FOR SHAREHOLDERS and for the man whom many blame for GE's woeful stock-market performance since 2001 -- CEO Jeffrey Immelt.
Immelt was hand-picked to lead GE in 2001 by his predecessor, Jack Welch, after a much-publicized competition among several top executives. The change in command took place at the perfect time for Welch, who exited with a reputation as a corporate titan and master stock-price booster. But it was precisely the wrong time for Immelt, coming in a year of the 9/11 attacks, a recession and a stock-market slump. In the years that followed, investors rarely rewarded GE for any gains and roundly punished it for missteps, especially those made during the housing and credit bubbles.
There have been periodic calls to break up the company, and some shareholders would prefer a different CEO. But now, as Immelt, 55, approaches his 10th anniversary at the helm, his strategy -- focusing on infrastructure and a narrower offering of financial services -- looks sound, and GE shares look attractive. "Cold-eyed investors should be increasingly encouraged about the prospects of GE's growth machine to get back on track," Dray wrote after the company's fourth-quarter earnings release in January.
For the next 12 to 18 months, GE Capital will carry the load -- one portfolio manager expects that in 2011 it will double last year's $3.3 billion profit -- and then later-cycle businesses, such as power generation, locomotive production and aviation, will grasp the baton. Dray rates the shares a Buy, with a 12-month price target of 25; it was trading around 20 late last week.
Improvement is already apparent. Fourth-quarter earnings from continuing operations were 36 cents a share, versus 27 cents a year earlier, on consolidated revenue of nearly $41.4 billion–the first increase in nine quarters. This year, earnings from continuing operations should come in at $1.33 a share, versus $1.15 last year. Revenue should come in north of $142 billion, down 5% from last year -- partly owing to shrinking GE Capital and to divesting a big piece of NBCUniversal. The operating profits would still be well below the peak of $2.19 hit in 2007. Robert MacDonald, associate portfolio manager of Thornburg Value Fund (TVAFX), thinks that $2 a share "is reasonable in a couple of years." He uses a blended multiple: 15 times for the industrial earnings, roughly in line with companies such as Emerson Electric (EMR) and Honeywell International (HON), and 13 times for the financial earnings. That gives him a one-year price target around 28.
The 2011 profit gains won't come uniformly across GE's businesses. Aviation is expected to be flat, thanks to heavy R&D spending. Health care has the potential for double-digit operating-earnings growth. And big-ticket power-generation products like gas and wind turbines remain pressured. But the underlying trends are excellent, with a $175 billion year-end order backlog, nearly 75% of it in highly profitable contractual-service agreements. When GE, for example, makes a jet engine, the profitability really kicks in after the initial sale, owing to continuing revenue from spare parts and maintenance, repairs and other services. In fact, about 70% of GE's industrial profits came from service in 2010.
As of Dec. 31, GE had about $19 billion of cash, providing ample flexibility to make acquisitions, boost its dividend or increase share buybacks. It got about $6 billion recently from its deal with Comcast (CMCSA), in which it reduced its stake in NBCUniversal from 80% to 49%. Comcast now runs the entity.
Last year, GE had $14.7 billion of operating cash flow, even though revenue ran 3% below 2009's level. And, after slashing its payout in 2009, it raised the quarterly dividend twice, the second time to 14 cents a share. At its recent price around 20, the stock sports nearly a 3% yield. And, Immelt tells Barron's, without providing specifics, "we are going to keep growing the dividend." He also sees more stock buybacks -- GE's current authorization allows it to repurchase $10 billion worth through 2013 -- and more "small bolt-on acquisitions," generally costing $1 billion to $3 billion........MUCH MORE