These Electric Companies Are Undervalued!
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Emerson Electric (NYSE: EMR) and General Electric (NYSE: GE) are two of the more attractive industrial stocks in terms of their diversification and bullish reinvestments. While many risk-averse investors seek out firms with dividends, ironically, the safest companies can be found in those that do not offer dividends and feel confident enough that they can get better returns for investors through reinvesting earnings.
Emerson, for example, offers a 2.7% dividend yield and has demonstrated confidence over the fundamentals elsewhere. The decision turns out to have been a smart one, as Europe has proven to be less of a retardant than expected. In addition, although defense has lagged and been under pressure from concerns over cuts, commercial aviation margins in aftermarket goods and services has done well. The company also has a good tailwind coming in from smart grid applications where electrical energy demand is starting to rise in emerging and developed economies.
At the same time, the company only recently had its first strong quarter after a string of misses. Net debt of $3.2 billion is still not concerning, and the balance sheet is solid enough to make incremental investments. Although management has guided for record EBIT margins of 18%, I am still weary of an investment given how volatile margins are, particularly in Network Power. This problem is only expected to get worse when $100 million is funneled into restructuring European operations.
General Electric, on the other hand, is an-all-around strong investment. The business has become more of a financial company over the years, although it has started to invest a lot in wind energy. Aviation & healthcare also represented just more than one quarter of the business last year. GE is cheaper than Honeywell (NYSE: HON) on a PE multiple basis and is currently rated a "buy" on the Street.
Equipped with a strong brand and plenty of room for penetrating emerging markets, it is likely for the firm to realize strong risk-adjusted returns during a period of macro uncertainty. If you project analyst expectations forward and discount backwards by 10%, it turns out that the company has nearly a 60% margin of safety. Only if the market factored in a 20% discount rate off of analyst expectations would the stock be fairly valued.
And GECS, which many viewed as being a liability in the sense of adding too much risk, has turned out to be a major cash cow. 2009 was a macro stress test, and GECS ended up holding up fairly well. Although the free cash flow yield is currently around 5%, it is likely to double once GECS dividends return next year - something that is not being fully appreciated by the market. Accordingly, I recommend buying shares before this is realized.
Honeywell is another possible investment that you may want to consider making. In my view, it is around fairly value. The multiples are higher than peers, so upside beyond financial momentum will be limited. On the positive side, the firm's ability to deliver 4% annual organic growth in the second quarter demonstrated strength in navigating cyclicality - a very compelling reason to buy shares for those that were on the fence due to macro uncertainty. Greater visibility in Europe has further lessened the reservations while a new control system promises a strong steam of revenue from oil & gas plants once the economy heats back up. All in all, however, GE and Emerson seem better positioned in terms of innovation and more likely to have valuable assets become suddenly appreciated by the market.
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