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Using the Value Line Page: Is GE a Fallen Angel? October 22, 2010
There are numerous styles of investing ranging from value to growth to income. Each style has its own particular strategies; one strategy that falls under the value marquee is the search for fallen angels. Fallen angels are once dominant companies that have fallen on hard times for any of a variety of reasons. Investors in these types of companies are, essentially, hoping that the angels can earn back their wings and fly again. General Electric (GE – Free Analyst Report) has fallen on hard times—but is it an angel working to regain its wings or a corporate has-been?
General Electric is one of the largest and most diversified industrial companies in the world. Its main business segments include Energy Infrastructure (24% of 2009 revenues), Technology Infrastructure (27%), Consumer and Industrial (6%), and Capital Finance (33%). Recently sold NBC Universal accounted for 10% of 2009 revenues. About 54% of revenues in 2009 came from overseas. Although this overview, provided in the Business Description on the Value Line report, gives an outline of the company’s size and scale, it only hints at the company’s rich history and recent troubles. (A free copy of the Value Line report for General Electric for use with this article can be found here.)
In a conglomerate as large and diversified as General Electric, corporate leadership plays an especially large role in the success or failure of the company. Indeed, General Electric’s two most recent leaders (the company traces its history all the way back to Thomas Edison) have had an enormous influence on the present form of the company. In the early 1980s, Jack Welch became CEO and worked to restructure and modernize the company. This earned him the nickname “neutron” Jack because of the layoffs that accompanied his restructuring efforts. His moves, however, created a lean and well-run company that consistently created wealth for its shareholders. One of the hallmarks of the Welch era was his oft-stated aim to have GE hold the number one or two position in all of the businesses in which it participates. Any business line that couldn’t compete at this high level eventually went away. The company became a stock-market darling with a long history of solid earnings and dividends that were a testament to Welch’s leadership. Welch retired at the turn of the century, but a portion of the company’s performance under his stewardship can be viewed in the historical portion of the Statistical Array.
Welch’s successor, Jeffrey Immelt, had a tough act to follow and almost immediately came under pressure for not living up to his predecessor’s legacy because of a languishing stock price and his more distant personality. The recession beginning in 2007 only worsened the market’s perception of GE’s leadership. Immelt’s GE had been relying heavily on its finance unit for profits when the recession hit. This caused earnings to fall off materially, which can be seen in the Statistical Array where 2007 represents a high water mark for earnings. A two-year earnings decline followed, which saw profits fall by more than 50%. This coincided with a dividend cut in the middle of 2009. This can be found in the Quarterly Dividends Paid box at the bottom left of the page. This was a clear and troubling statement for a company that, prior to the cut, had prided itself on regular dividend increases.
Needless to say, investors didn’t react favorably to these developments, sending the shares to a low of about $6 in early 2009. The Graph clearly illustrates the dramatic share price decline. Immelt even drew the ire of his predecessor for letting investors and analysts down.
By early 2009, GE was clearly a fallen angel. But can it get its wings back? Immelt didn’t get to his current position because he was a bad manager. He has made some very difficult decisions and has been positioning the company for the future.
Immelt has cut back some areas, such as the NBC media group that had for years been considered an odd fit, and building others. The general focus has been on industries that the company believes are future growth markets, such as environmental and health care related businesses. The changes appear to make sense, but results have been slow in coming. Still, material corporate change at a company as large as General Electric will normally take time. That said, with nine years or so at the helm, Immelt has little to show for his tenure.
Indeed, the widely diversified industrial giant reported mixed results for the third quarter of 2010. Revenues slipped 5% from the prior-year period and came in well below our forecast. Equipment sales continued to disappoint, with weaker-than-expected demand at the Energy Infrastructure and Aviation units largely to blame. Further, although performance at the GE Capital finance division has gradually improved, reduced assets under management remained a drag on the results of this division.
Are Immelt’s changes enough to earn this fallen angel’s wings back? Value Line analyst Damon Churchwell believes that 2009 was the low point, however, estimating a slight earnings advance for 2010. Despite challenges, General Electric’s share-net tally topped our estimate in the third quarter. Indeed, excluding its NBC Universal entertainment unit (which was recently sold to cable heavyweight Comcast), the operating margin expanded by 40 basis points, to 16.4%, as the company did an admirable job of cutting expenses where needed.
Though the conglomerate may suffer some bumps and bruises over the near term, it appears well positioned for the long haul. In fact, share earnings are projected to grow steadily out to 2013-2015 when share net is expected to reach the $2.60 area. The Annual Rates box highlights the expected growth rate for earnings while the estimates in the Statistical Array show the earnings projections on a per share basis. Consequently, General Electric stock holds wide appreciation potential over that time frame.
The price projection of $30 per share on the low side and $45 on the high side translates to a gain of between 75% and 160%, excluding dividends. The share price range and the gain can be found in the Projections box on the left side of the Graph, while a visual representation is denoted by the dotted lines to the right side in the Graph. This, of course, assumes that Immelt gets the company moving in the right direction.
Note, too, that the company has resumed dividend increases with the fourth quarter 2010 payment. The increase, from $0.10 per share per quarter to $0.12, can be seen in the Quarterly Dividends Paid box. Moreover, at nearly 3%, the dividend yield on General Electric’s stock is fairly generous. Adding it to the price appreciation projections results in annualized total return projections between 17% and 29% (which can be found in the Projections box).
We think GE is a fallen angel that it is undervalued on most historical measures. The question that investors must answer is whether or not the current price is a new trading range for the company or if recent moves will vault the diversified giant back to its former glory. We expect the latter, but note that regaining one’s wings can be an arduous task fraught with risk. Thus, the stock is most appropriate for venturesome investors that have the patience to ride out share price and earnings volatility.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.