Berko: GE stinky, but buy those shares and hold your nose
By Malcolm Berko
Published: January 14, 2018, 6:00am
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Dear Mr. Berko: My stockbroker wants me to buy 400 shares of General Electric. Is he nuts?
— J.S., Moline, Ill.
Dear J.S.: Last June, Jeff “Big Melt” Immelt, who took control of General Electric (GE-$18.47) from the iconic Jack Welch just before 9/11, announced he’d be stepping down as CEO. Good! He’s been replaced by John Flannery, a 30-year GE veteran who ran the company’s health care division. Huge yawn! Most doubt that Flannery and his personal broom can hurry GE’s price recovery. So far, his appointment has made as much difference to GE as would the advent of another fly to a slaughterhouse. That should change if Flannery’s broom can muck out the executive suite and remove the stench from the Augean stables in GE’s useless boardroom.
Recommending GE at $25 several years ago was among my biggest disappointments since buying 250 shares of Studebaker-Packard in 1962. That company shut its doors in 1966. GE, with $126 billion in 2016 revenues and $13.4 billion in profits ($1.07 a share), wasn’t earning enough to pay its 96-cent dividend, so Flannery reduced it to 46 cents, saving the company over $4 billion a year. GE’s not in trouble; it just lost its mojo.
GE’s established dominant product categories — turbines, locomotives/transportation, lighting, medical imaging, renewable energy, aircraft engines and service contracts — do very well. Its service contracts business generates margins in excess of 30 percent.
GE’s problem is fivefold:
1) Integrating the power and grid business of Alstom, a French company GE purchased for $14 billion in 2015, has proved more difficult than anticipated. Slow penetration in the European power infrastructure is disappointing. Still, 30 percent of the world’s electricity is generated by GE equipment. Recent events suggest modest success and profits this year.
2) Volatile fossil fuel prices are hurting GE’s oil and gas segment, an important growth platform for its slowly growing industrial portfolio. However, oil prices are expected to remain at current levels ($55 to $62 a barrel) through the first half of 2018.
3) It may take several years for GE’s industrial division to replace the significant, albeit slightly worrisome, earnings from GE Capital, which Immelt stupidly unwound in 2015.
4) Observers believe that integrating oil field service provider Baker Hughes’ business, which GE purchased for $7.5 billion, will be more difficult than anticipated, as the sale was predicated on oil’s trading at $60 a barrel.
5) Finally, bigger isn’t better. GE is so ginormous (301,098 employees in 180 countries) that it’ll take GE’s brain a week to discover that competitors are eating its tail.
However, GE should slowly stagger forward, and I’m comfortable staggering forward with a 48-cent dividend yielding 2.7 percent. If 2018 revenues come in at $132 billion and produce profits of 90 cents a share — as is projected — GE may even raise its dividend to 50 cents this year. If Flannery can hold the reins steady during the coming four years, analysts believe that net profit margins could improve from 8.9 percent to 15.3 percent. Analysts believe that 2022 revenues could come in at $165 billion, that earnings could reach $2.20 a share and that the dividend could be increased to a buck again. That’s a potential 5.5 percent yield at today’s $18.47 price. There are quite a few ifs, but if those ifs can reach reality, aficionados believe that GE could trade in the $50s by 2022.
There’s impatient buzzing by some activists suggesting the best way to maximize shareholder value would be to divide GE into four independently traded companies — dealing with medical imaging, aircraft engines, oil and gas service and equipment, and power generation, respectively — each with profitable service contracts. These four independent companies could have a combined share value of $50 to $60 within 18 months.
Your broker gave you good advice. GE’s long-term debt is declining, while book value, return on capital, return on equity and cash flow are improving. Still, GE’s board members have egregiously failed shareholders and management. These toadies, who gleefully fleeced millions of dollars in perks and directors’ fees, are responsible for GE’s humiliating performance. They should be pilloried, placed in stocks, publicly whipped and then prosecuted for malicious misfeasance. Buy 400 shares, but hold your nose!
