Conglomerate Matchup: GE Vs. MMM

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

GE and 3M have done a strong job in recovering from the financial crisis. However, in my view, they face very different prospects going forward. While one has made sound investments that complemented the core segments, the other has set goals without delivering impressive organic momentum. Below, I provide my take on these two conglomerates.

General Electric (NYSE: GE)

General Electric is America's largest industrial company with diverse interests ranging from medical equipments to jet engines. Even a cursory glance of 2012 first quarter report reveals that the company is shifting towards industrial segments and away from financial services--precisely what the market demanded. The economic crisis had battered its finance arm and resulted in the suspension of dividend distributions in 2009 . Now, the company is increasing its dividend by 12% to a yield of 3.5%, which more or less tops the sector. 

General Electric has used its newfound success to acquire complementary businesses. It had entered into a deal to purchase the aviation unit of Avio from PE firm Cinven, which represented a multiple close to 8.5x estimated earnings. The firm also plans on investing $11 million to improve its manufacturing facilities in Slater, Missouri, which will create 115 jobs. Its financial arm now plans on investing as much as $100 million in venture capital to mark the entry into the “Industrial Internet”. The rationale behind the concept of “industrial internet” is that machines and corporate systems would be made more efficient and through this transition, GE expects to improve efficiency to the tune of at least $150 million.

In regard to energy, GE also won a $394 million contract from Brazil-based wind energy developer Renova Energia, wherein the conglomerate would supply 230 wind turbines for the Alto Sertão II Wind Farm. GE is given the right to operate the wind farm for a decade. All of this momentum has prompted Citi to rate the stock a "buy".

3M (NYSE: MMM)

According to Business Insider, 3M ranks as one of top ten stocks vying for investment in 2013. The company's five year target is to grow EPS by a rate of 9-11%, grow organic revenue by a rate of 4-6%, and generate a 20% return on invested capital with 100% free cash flow conversion. This will be supported by an increase in R&D spend to 6% of sales.

The CEO has acknowledged how these are largely stretch targets. In my view, this creates downside potential on the stock. I believe this because, in the third quarter, revenue of $7.5 billion was short of expectations by $130 million.

Over the past 5 years, the company grew EPS by only 2.5%, which is well below the 9.8% rate that is expected over the next 5. This is yet another reason why I believe there is downside potential to the current stock price. To mask these structural weaknesses, the company has focused on increasing scale inorganically, such as through the the acquisition of Ceradyne.

Conclusion & Stock Fundamentals

As expressed above, I believe GE has more promising tailwinds than 3M has. However, has the market factored a similar assessment into the respective stock prices?

GE trades reasonably at 17x past earnings. In my view, its free cash flow yield of 3.7% is a bit on the low side but this is compensated by the 11% EPS growth rate forecast and strong execution with positive quarterly surprises. 3M is only slightly cheaper at 16.5x past earnings. However, it has a free cash flow yield of only 3% and is forecasted for just a single-digit EPS growth rate. It also carries significantly less volatility at a beta of 0.89, which, in this bull market, I believe is actually a bad thing--investors should be hunting out the riskier stocks that can either grow fast or close a value discount fast.

For the best of both worlds, I recommend a different conglomerate, Tyco International (NYSE: TYC). This producer of security & protection systems is comparatively cheap at 15x forward earnings, and it is generating a free cash flow yield of over 6%. In addition, it is forecasted for a much stronger growth than GE and 3M at around 17.5% annually. With a beta of 1.16, it can also close this discount to peers fairly quickly.


David Gould has no position in any stocks mentioned. The Motley Fool recommends 3M. The Motley Fool owns shares of General Electric 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a long position in the next 48 hours.

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