What GE Needs to Keep Rising
By Amey Stone
Investors have made easy money in General Electric (GE ) lately. The stock, which closed at $29.10 on May 1, had dipped to around $22 in mid-February, when its price-earnings (p-e) ratio was only 13 -- well below the Standard & Poor's 500's 17. It was one of the few such reversals in the outfit's long history, and it made GE a clear value play. Investors who snapped up shares have enjoyed a 32% gain in just 2 ½ months.
Going forward, the gains won't be so easy. Now, the stock is valued at about a 5% premium to the S&P 500, with a p-e of 19, vs. the S&P's 18. Historically, that's still low: In the last 10 years, GE's market premium averaged 60%. And since it's not as enticing to today's short-term traders, the price may well stall in the near term as investors take some profits.
"This run-up in stock price was, in part, to correct an undervaluation," says Sonya Thadhani, a portfolio manager with investment firm Bailard, Biehl & Kaiser in Foster City, Calif. "Anyone looking to make a little money in this environment would have seen that." Based on technical analysis, it would be tough for the stock to break above $30 anytime soon, says Todd Salamone, vice-president for research at Shaeffer's Investment Research.
For GE to move higher -- and retrace the long road to its August, 2000, high of $60 -- CEO Jeffrey Immelt, who succeeded Jack Welch in September, 2001, will have to convince the Street that he has reduced the near-term risks (both macroeconomic and GE-specific) that led many investors to sell earlier in 2003. More important, he must demonstrate that he can lead the mammoth conglomerate to long-term, market-beating results. It's likely he has a few more quarters of proof to provide.
Kerry Stirton, an analyst with Bernstein Research, believes Immelt is up to the job. Stirton, who projects GE's long-term annual growth at 9.5%, says the stock is still undervalued, based on his projections for 2004. He expects GE, which earned $1.51 a share in 2002 (or $15.1 billion on sales of $132 billion), to earn $1.61 per share this year and $1.80 in 2004. Says Stirton: "For long-term investors, there's still a lot left."
A cautiously optimistic Thadhani, who is a long-term holder of GE shares, still believes this is a time for investors to take "a little bit of a wait-and-see" approach. "Can we expect the same out of GE as we have seen in the past?" she wonders. "I'm hopeful."
One reason GE rocketed in April: First-quarter results went a long way toward convincing investors that it's getting back on track. True, earnings were down 9% from the first quarter of 2002 (at $3.2 billion, or 32 cents a share, vs. 35 cents) and revenues were 1% lower, at $30.3 billion.
Still, investors were pleased that GE's beleaguered Power Systems division, which makes large generators for power plants, held up better than expected. The other main trouble spot -- the reinsurance division -- also is showing marked improvement. Last year, GE had to take a $1.4 billion hit against earnings to increase reserves depleted by huge claims, mostly due to the September 11 terrorist attacks.
The second quarter will likely show another year-over-year decline in earnings (38 cents a share, vs. the 43 cents), mainly because that was when Power Systems' business peaked. (GE shipped 86 large generators in the second quarter of 2002, vs. a likely 24 or so in the second quarter of 2003).
Looking to the second half of 2003, GE's results will benefit from easier quarterly comparisons in that division, plus improved pricing and management of the reinsurance operation. Analysts expect earnings to start a year-over-year ascent in the third quarter (to 43 cents a share, vs. 41 cents in 2002) and then really take off by the fourth quarter, to 47 cents a share, vs. 31 cents in 2002. If it succeeds in producing that kind of second-half earnings spurt, many investors would be eager to rejoin the GE fold.
Another important lure for long-term investors in the first quarter was better financial disclosure in the massive finance division, GE Capital, as well as steps to improve earnings quality, compensation practices, and financial accounting. These are all hot buttons in the current climate, where disillusioned investors are still nursing their wounds over losses incurred during Wall Street's spate of scandals.
The Street had been particularly worried this year about the possibility of a credit crisis at GE's commercial-finance division, but an April conference with investors went a long way toward convincing them that the operation is stable and well-managed, says Bernstein's Stirton.
"The veil is off in terms of GE being a rock-solid company that's never going to disappoint," says Richard Moroney, editor of the Dow Theory Forecasts newsletter. "But this year is shaping up to be not too bad relative to what people had been fearing." He still thinks it will take at least two more quarters for Immelt to rebuild GE's reputation for consistent long-term growth.
Moroney's biggest current concern: GE's aircraft-engine division, which contributed about 15% of first-quarter profits. Given current weakness in the airline industry, "I don't see how that business is going to stop falling apart," he says. Overall, he adds, "There are still a lot of moving parts where something could go wrong."
The broader global economy remains the biggest wild card -- many of GE's industrial businesses are tied to its fluctuations. Nonetheless, for investors with a three-to-four year holding period, Moroney thinks GE is still as solid a bet as any.
For investors with a short-term mentality, that sounds like an awfully long time, especially given the stock's heady gains in just the past couple of months. But as Stirton puts it, "A stock like GE doesn't just continue to rocket up -- it goes in little leaps."
Investors looking for another sharp spike may have a while to wait, and plenty of near-term risks remain. But Immelt is starting to prove that he can deliver the kind of results long-term shareholders grew to expect. So, for investors with a longer perspective and faith in the underlying strength of today's wobbly economy, it's increasingly likely that blue-chip GE will reward their patience.
Stone is associate editor for BusinessWeek Online in New York
Edited by Beth Belton