I don’t make a lot of changes to my 401(k) account. Heck, I barely touch the thing. That&rsquo...
GE Offers a 3.6% Yield and a Low Risk Internal Earnings Growth Story
03/19/2015 9:58 am EST
The internal growth story of this company—a result of continued restructuring—is not dependent on a recovery in any part of the global economy, so MoneyShow's Jim Jubak is raising his target price as of Wednesday, March 18.
In case you haven’t noticed, growth isn’t exactly busting out all over for global companies and their stocks.
All too often the growth story comes with a big dose of someday:
Someday the energy sector will turn around after oil has bottomed.
Someday demand for commodities such as copper and iron ore will rebound.
Someday the anti-corruption campaign in China will cool off and the country’s wealthy will feel safe buying Prada and Louis Vuitton again.
This environment is why I like shares of General Electric (GE) right now.
The company does have a good dose of someday to its story: the chaos in the oil and gas sector—the source of 11% of GE’s sales in 2013—has helped hold total return for the last 12 months (ended March 18) to 3.47% vs. 13.5% for the Standard & Poor’s 500. That’s even worse than it seems since the stock pays a 3.6% dividend. On price, these shares have gone nowhere in the last 12 months. (General Electric is a member of my Dividend Income Portfolio.)
Nothing like a company deciding to invest in building market share in a sector just when that sector hits hard times to knock some air out of a stock.
This dose of someday does, however, give the stock potential upside when the oil and gas sector does begin its recovery in the second half of 2015, or in 2016, or whenever.
But GE also has a strong internal growth story that’s a result of a continued restructuring of the company that moves it away from the huge reliance on revenue and earnings from GE Capital, built up during the Jack Welch years.
That part of the GE growth story is going on now and it’s not dependent on a recovery in any part of the global economy.
GE Capital, even after asset sales and spinoffs, still accounted for about 30% of revenue as of the end of 2013. The goal, CEO Jeff Immelt said in his recent shareholder letter, is to shrink GE Capital as a percentage of revenue even further to 25% by 2016.
Why is that a good idea? Wall Street has focused on the costs of the regulatory burden that GE Capital imposes on GE. The Federal Reserve and other regulators are requiring GE Capital to hold more capital and those increases in required capital cut into the return that GE earns on this part of its business.
But I’m actually interested in the potential growth story that shrinking GE Capital represents for GE. You see, the operating margin for GE Capital trails the operating margin for just about any of the company’s other business segments.
Operating margin at GE Capital has been falling over the last few years from 18.1% in 2013 to 16.4% in 2014. And it’s projected to continue to drop. Credit Suisse, for example, sees operating margins for GE Capital dropping to 13.5% in 2015 and then to 12.2% in 2016.
Meanwhile, GE’s aviation business shows a projected operating margin of 20.2% in 2015. For healthcare, the projected operating margin is 16.9% in 2015. For transportation, it’s a projected 20.2% in 2015.
Now General Electric has a number of initiatives in place to increase margins by cutting costs and increasing efficiencies and to continue to growth market share in transportation, healthcare, and aviation. I think those initiatives are starting to pay off; the company looks like it’s in the process of reversing the 1.5 percentage point drop in gross margins that it experienced from 2011-2014.
But GE could also show a higher rate of earnings growth simply by shifting its capital allocation away from the relatively low operating margins at GE Capital to the higher margins of its best industrial divisions. (I don’t think GE should get out of the capital business completely, because the ability to offer financing to industrial customers is a key to competing in those sectors.)
From this point of view, the recent sale of GE Capital’s consumer lending business in Australia and New Zealand to KKR (KKR), Varde Partners, and Deutsche Bank (DB) is especially encouraging to me. The $6.2 billion from that sale can now go into growing GE’s businesses with higher profit margins. (Or it can be returned to shareholders. General Electric has growth dividends to a current annual 92 cents a year from 70 cents in 2012.)
I’m raising my target price just slightly to $31 a share from the prior $30. And I’ll be happy to collect the current 3.6% yield while I wait for GE’s two sources of growth to add to revenue and earnings. The shares closed at $25.64 on March 18.
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