GE: Aviation Unit Could Propel Growth

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General Electric (NYSE: GE) is America's largest diversified industrial company. Ten years ago, it was headed toward being a huge, international finance company with some industrial operations. The banking crisis put an end to that, and as GE Capital has shrunk its assets, General Electric's core, industrial and manufacturing capability has carried the company. General Electric makes, sells, finances and services everything from locomotives to jet engines to medical equipment to household appliances to wind turbines.


First let us turn to GE Capital. It historically had paid 40% -50% of its earnings to its parent, which by the mid 2000's had been as much as $8.6 billion in one year. The dividend was suspended in 2008, and as GE Capital passed the Federal Reserve's recent stress test, it is likely that the dividend will resume later this year, contributing as much as $3.1 billion to its parent company. 2011 profits for GE Capital were just over double from the 2010 result, or $6.5 billion. Further gains are likely, though doubling again is out of the question. I look for 2012 GE Capital earnings of $6.8 to $7 billion in. General Electric is committed to reigning in its finance arm to focus on General Electric customers, and industries with which it is uniquely familiar. General Electric sold or closed down numerous segments of GE Capital in the past eighteen months. These include the consumer/RV/marine unit, Consumer Mexico, and Consumer Singapore.  GE Capital accounted for about 45% of General Electric's overall profit last year, the highest ratio since 2007. Yet, I do not see GE Capital's profits approaching the $12 billion mark it was in 2007 anytime soon.


As for the rest of the company, General Electric divides its industrial operations into energy infrastructure, aviation, healthcare, transportation, and home and office solutions. General Electric is a world leader in conventional energy systems, as well as wind turbines and solar systems. I am concerned about this business as tax incentives in the United States for alternative energy are under question going forward. While 49% of General Electric's revenues are from overseas, the United States is the company's principal single market. Energy Infrastructure sold a record high $43.7 billion last year, and management believes it is the future main growth driver of the company. But earnings from the unit of $6.65 billion were the worst since 2008 and down almost 9% from 2010's $7.27 billion. In 2011 the energy infrastructure unit accounted for 46% of industrial revenue, and 48% of industrial pretax profit.


New generations of aircraft, such as fuel efficient Boeing 737 MAX and Dreamliners, auger well for the near term future of the aviation unit. Revenues at the unit in 2011 of $18.9 billion were up from 2010’s $17.6 billion. But profits in the unit were $3.51 billion, still $400 million below the recent high set in 2009. In 2011, the aviation unit accounted for about 20% of industrial revenues, and 25% of industrial pretax profits.


The other big unit for General Electric is its healthcare unit. General Electric is a world leader in magnetic imaging and other sophisticated diagnostic hardware, and has growing pharmaceutical sales as well. In 2011, the unit's revenues were an all-time high $18.1 billion, an 8% improvement from 2010. Profits in 2011 were $2.8 billion, or a narrow, 2% advance from 2010. 2011 healthcare unit revenues accounted for about 19% of industrial revenue, and about 20% of industrial pretax profits.


Overall, company earnings in 2011 continue General Electric's long climb back to pre-recessionary levels. The $14.15 billion in earnings was an improvement of 13% over 2010 after accounting for the loss of General Electric's ownership of NBC / Universal. With help across all segments, profits of $16 billion or more is probable in 2012. The company offers a 3.5% dividend yield, and a 12 month price target of 19% above today's price, offering a compelling total return. While the near term is attractive, General Electric is a company whose earnings, and stock price, can easily double out to mid-decade. General Electric's 5 year PEG of 1.05 indicate it is potentially undervalued at current levels.


There is only one company with the breadth and scope of General Electric, and that is General Electric itself. But there are a few other large, diversified manufacturing companies out there. Foremost is probably 3M Company (NYSE: MMM), the makers of myriad industrial and household products. It does not have the growth prospects nor the margins of General Electric. What is does have is an impeccable dividend history, having raised its distribution 53 years in a row. Even so, its yield is lower than General Electric’s. 3M has a 5 year PEG of 1.4, and I view the company as a hold, not a buy, at current levels.


The big difference between 3M and General Electric is that 3M has fully recovered from the recession last decade, whereas General Electric has not. We may as well take advantage of that fact and ride the continuing recovery of General Electric.


The other company that comes to mind as a more or less direct competitor of General Electric is United Technologies (UTX).  Its Pratt & Whitney unit competes directly with General Electric's aviation unit, and United also owns such diverse companies as Otis Elevator, Carrier HVAC, and Sikorsky Helicopter, among other units. United's margins are far below General Electric's, but analysts see substantial revenue and income growth through 2013. United has a 5 year estimated PEG of 1.2, and I view the company as a terrific intermediate term holding. 

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