So here we are in earnings silly season, and one of the big players will report this week: General Electric (GE).
GE earnings are often considered important for the market as a whole, but these days, I place even more weight on the company’s earnings reports than I used to. The economy is in a very fragile state, and GE stock is so diversified across so many segments that it should provide a solid picture about just how bad (or good) the economy is doing.
GE stock carries products ranging from wind turbines to aircraft engines and rail equipment appliances. the stock also has a large financial arm. In fact, GE Capital makes up almost a third of GE earnings — or rather, its operating profit.
Management has been keen to focus more on its industrial business, and is attempting to downsize its financial exposure. I don’t particularly care for this strategy. Financial services are a critical part of both the American and the global economy. There is a need for innovation in the credit markets, as both businesses and consumers struggle with antiquated policies regarding credit. GE Capital should be innovating; instead, it’s shrinking and thereby contributing less to GE earnings and GE stock performance.
GE stock is in an interesting position. Revenue growth has been down YOY, while EPS has been climbing at a 9-10% clip. Thus, the EPS growth is resulting from cutting expenses and the company buying back GE stock.
That kind of strategy is fine for a short period of time, especially since the company generates such robust FCF. GE stock isn’t going to zero anytime soon, and the company is on solid financial footing. However, sooner or later, shareholders may get tired of the lack of organic growth and not be willing to pay for it.
That’s why I go back to GE Capital, and why I think think there’s opportunity there that the company is ignoring while it waits for the global economy to kick back into gear.
The average estimate for GE earnings is 53 cents for the quarter, and $1.64 for FY13. Sales growth is expected to be a measly 2.3%, bringing the total year to -0.9%. Normally, if I saw a company selling at a little more than 16x earnings, when earnings are not growing organically at all, I’d run. However, as mentioned, GE stock has great cash flow.
Operationally, GE stock generated $31.3 billion, $33.3 billion, and $36.1 billion in FY12, FY11, and FY10, respectively. For the first three quarters of FY13, cash flow is at $17.2 billion. Q4 is traditionally the company’s strongest cash flow quarter, so the full-year figure should bump up around the $30 billion mark. GE stock has $130 billion in cash and pays a 3.3% yield, which doesn’t hurt investors waiting for a recovery.
If the earnings growth for GE stock were totally organic at 10%, given that yield and that cash flow, I’d gladly pay 16x earnings. So while GE stock feels expensive at the moment, it’s difficult to just cast the company off unless things get materially worse going forward. I am long GE, and have been for some time. I will be holding for the very long term, unless I see evidence of internal cracking in the company’s business.
As of this writing Lawrence Meyers was long GE.