Tuesday, 17 June 2014

Is GE a buy?

I believe GE is undervalued and misunderstood by market as it transition it's earning base from GE Capital to Industrial segment. This has been a multi-year transition process which is concluding to end by 2014-15. However, market is still skeptic about the transition, providing long term investor an opportunity to buy shares at significant discount to its intrinsic value.

My analysis shows that GE is worth atleast $360-370b. With current market cap of 267b, its has 35-40% upside with no growth assumption build in my analysis. The analysis is based on sum-of-parts analysis and capital return to shareholders over next 4-5 years as explained below:


Valuation



As per annual letter, GE will return 90-100b of capital back to shareholder in next 4 years, adjust that to current market cap, investor is paying 170b for GE.

GE Capital book value is about 82b with cash earning of about 9b in 2013, ROTE 16%. Given management is scaling down GE Capital, I believe BV will come down around 70b. 1.3x BV or 10x cash earning, GE capital is about 90B.

170B less 90B = 80B, investor is paying 80B for industrial business earning about 12-13b pre-tax in 2013;that's 6-7x multiple which is pretty cheap. I'm willing to give market multiple of 15x for industrial with no growth projection.

Now let's work backward to calculate intrinsic value of GE:


Cash to shareholder: 100b
GE Capital: 90b
GE industrial: 12b  * 15 =  180

Add all of them, GE is worth 370B, trading about 270B. Investor has 37-40% upside with no growth assumption built in the valuation. With minimal 5-7% increase in industrial earning growth, valuation will be north of 390-400b.

GE is one of the cheapest DOW component trailing market advances significantly. I see earning growth in industrial combine with dividend increase and share buyback as catalyst to share price increase over next 3 years. Patient investor get 3.2% yield for waiting.

P.S: I am long GE in a concentrated portfolio