What GE Needs To Do & 1 Other Conglomerate "Buy"

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Since the 1980s, Wall Street has pushed its clients to move away from conglomerates. They argue that it makes it hard for investors to rationally value assets. For example, if you have a low margin, risky aviation business mixed in with a high reward energy business, investors may not take time to fully value the latter in light of the former. "Bundling" different businesses together can be inefficient, especially when those individual pieces are worth more to a synergistic buyer. With that said, there are a few conglomerates that are worth considering..

A Look At 3M (NYSE: MMM)

3M is near its 52-week high after rising 21.1% from the 52-week low. However, there are still reasons to be optimistic. Bank of America even lists the company amongst its Top Ten favorite stocks for 2013. I further like the company's focus on yielding certain metrics: a 9-11% EPS growth rate, 4-6% organic top-line growth, over a 20% return on invested capital, and a hike in R&D spend to 6% of sales. But bear in mind the company's track record: it recently came to the conclusion that 7-8% revenue growth was a "stretch" after third quarter revenue of $7.5 billion came out $130 million short of expectations.

The company therefore plans to build upon its existing foundation through takeover activity. Management has spoken about doing deals in an ideal environment and not when everyone is jumping about in a way that reduces bargaining power. But it has been very successful with R&D. Over the last 5 years, R&D spending has gone up by 16.6% while free cash flow has gone up by nearly double that amount (32%) to $3.9 billion.

3M is forecasted for 10.6% annual EPS growth over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $9.27. At a multiple of 16x, this translates to a future stock value of $148.32. Discounting backwards by 10% yields a present value roughly in-line with the current market assessment. Thus, while I do not believe the company is undervalued right now, I find that it's worth the growth and dividends.

Why You Should Buy GE (NYSE: GE)

To get a clearer sense of GE's business, here is the 2011 revenue breakdown:

GE Capital: 32.7%

Energy infrastructure: 31.3%

Aviation: 13.5%

Healthcare: 12.9%

Home & Business: 6.1%

Transportation: 3.5%

So, two-thirds of the company is involved in financials and energy. First, the GE Capital crisis looks like it is behind the company as losses are expected to fall from here--Citi is even forecasting double-digit earnings growth. With this headwind out of the way, investors can start to focus where I see a strong catalyst: energy. The shale boom has seen discoveries outpace production growth, and analysts are speculating that oilfields service firm Weatherford (NYSE: WFT) may be at play. The company trades at 7% under book value and is entering profitable territory, so a suitor should come sooner rather than later. Shares are down 40.9% from the 52-week low, and yet analysts continue to be optimistic on the firm. Just a few days ago even, Deutsche Bank called it a $21 stock, which is at a ~95% premium to the prevailing price. This transaction would generate meaningful revenue and cost synergies to the company's current energy business by helping to more directly supply its end markets.

For a long time, however, GE has focused on energy outside of natural gas. GE recently decided to signed a $394 million agreement with a Brazilian wind power company to supply 230 wind turbines. GE has already installed 20,000 worldwide, but, in 3Q12, only 241 turbines were ordered, a 69% y-o-y decline. Greater diversification into natural gas would help the company's upside story, since natural gas prices are at a low. It has shown an interest in targeting natural gas utilities through its $11 million 5-year investment in production facilities, but this is still chump change for a $220 billion company.

After all, the company is taking an acquisition strategy in its third-largest segment, Aviation. It recently purchased Avio from Cinven for $4.3 billion, or 8.5x 2012 earnings. Avio is a producer of commercial and military jet components. Weatherford is worth only $8.3 billion, so a buyout is easily within GE's reach and would communicate to the market that it can do more than $11 million.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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