Buy GE, Stay Away From 3M
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When it comes to diversifying, many investors look towards conglomerates. While I believe index fund investing is the ideal way to go about diversification, conglomerates are nevertheless worthy of exploring. "Integrating" and "consolidating" used to be a large part of business; since then, many companies have moved towards focusing on the "core". While the benefits from economies of scale and cross-selling create value in the former, efficiency and improved managerial focus create value in the latter. Below, I review the fundamentals of two noteworthy conglomerates: General Electric (NYSE: GE) and 3M (NYSE: MMM).
GE is diversified across a variety of industries ranging from aircraft engines to power generation to household appliances to financial services. Segments include Energy Infrastructure, Healthcare, Aviation, Transportation, Home & Business Solutions, and GE Capital. The stock currently trades at a respective 16.7x and 12x past and forward earnings, is currently rated around a "buy" on the Street, and offers an impressive 3.3% dividend yield. I recommend buying off of improving macro trends and strong growth
Free cash flow trends have struggled in recent years. FCF for the TTM ending 2Q12 was $24.1B versus $29.6B in 2Q11 and $34.6B in 2Q10. And yet the company has appreciated by 17.4% from the beginning of July 2010 to today. Earnings performance has been slightly better than expected with EPS of $0.37 in 2Q12. The company is on track to generate double-digit returns in the industrial and financial segment for 2012. At the same time, the GE Capital dividend returned $3B to shareholders in the 2Q.
Despite a challenging economy, housing start up over 30% and private label credit card, railroad links, and appliances all grew. Orders rose 1%, but organic growth took off 10%. Pricing power has improved, which sets a positive tone for business during the full recovery. In 7 of 9 regions, the company has seen double-digit gains - particularly in Latin America and China. When it comes to aviation, while the company has been up and down, margins are looking like they will improve. With greater business from equipment, margins are coming under pressure; but, R&D is starting to level off. Management should steer away from GE Capital and move towards industrial to win back some of the risk-averse investors. I recommend buying shares from this improving business story.
3M is another conglomerate that is worth considering. It trades at a respective 15.1x and 13.4x past and forward earnings with a 2.6% dividend yield and a beta of 0.9. Analysts forecast 11.2% annual EPS growth over the next 5 years.
Assuming the company meets expectations, 2016 EPS will come out to $9.52, which, at a 15x multiple, translates to a future stock value of $142.80. Discounting backwards by 10% yields a present value of $88.67 - implying that 3M is slightly overvalued. But when you factor in the 2.6% dividend yield and a 0.9 beta, 3M may be attractive from a safety perspective.
In my view, the stability does not outweigh the limited upside. Analysts currently rate the stock a "hold" and, while the quick ratio stands strong at 1.8, I do not see any accretive acquisitions generating outperformance going forward. ROA, ROE, and ROI may also all be in the single-digits, but the $64B company has generated only around $3.8B in annual free cash flow over the past half-decade. CAPEX has been properly restrained, but limited operating cash flow will prevent the firm from outperforming GE. Financially, the company is strong with around $5.2B in debt and $16.2B in liabilities, but both have been on the increase. I recommend holding out for firms with greater upside.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 3M Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.