1 Conglomerate To Buy, 1 To Avoid
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Large conglomerates often have to make aggressive investments in order to be thought of as something more than just a "macro bet." In this article, I focus on how GE (NYSE: GE) and 3M (NYSE: MMM) are branding themselves for the future. While I am optimistic on one, I am pessimistic on the other.
GE gets aggressive on energy
General Electric has been getting aggressive in energy. From installing new windmills to being cited as a potential suitor of Weatherford (NYSE: WFT), GE is evidently looking to increase scale both inorganically and organically. It is now planning to invest over $1 billion in Nigeria -- a development that should triple the energy output of the country in the next 10 years.
Nigeria currently has a very weak power sector, where more than 50% don’t have access to electricity. But GE’s investment will help the country reach their 2013 goal to fix all power problems before the year's end.
GE also entered a partnership with Honeywell Group to develop a 150MW solar plant. This is just a part of Honeywell’s 1000MW plan and should be completed by the end of 2018. There were no words if GE will be a partner throughout, but it strengthens the company's recognition as a major player in renewable energy.
Adding to this image, General Electric also had success in their software enhancements, with Turkey’s Zorlu Enerji Group now planning to adopt GE’s new windBOOST technology and 77.5MW wind farm at Gokcedag. This new technology will increase the efficiency of the turbines by 4%, or 85.25MW. This upgrade will help Zorlu Enerji reach their return on investment goal much more safely and quickly.
All of this focus on renewable energy also fits very nicely in the firm's "Industrial Internet" investment thesis. To make a long story short, GE is trying to sell the idea that it will be able to bring massive efficiency improvements to enterprises across the globe. As a whole, this growing focus on innovation will help attract back investors.
To get the most of the GE's upside, I would consider investing elsewhere in the energy sector. In particular, Weatherford looks cheap at 11.3 times forward earnings given that it's forecasted for double-digit earnings growth. This oil field service firm has gone through an accounting scandal, but is nevertheless well positioned to take advantage of renewed capacity in oil basins.
In general, I see strong potential in the oil field service market. Consolidation looks increasingly likely, which is why I think billionaire activist investor Carl Icahn is targeting Transocean. At a 25% discount to the market leader, Weatherford is an easy bolt-on acquisition for firms looking to increase scale. The company is financially healthier than recognized: it has a long-term debt/equity ratio of 0.22 and a current ratio of 2.6. Should GE acquire Weatherford, it can not only tack on a business with favorable secular trends in fracking but also unlock synergies with the energy unit.
Why you should avoid 3M
With Coca-Cola’s CEO Muhtar Kent joining 3M’s board of directors, could 3M come to be more of a blue chip stock? Certainly, it is taking steps to position the company this way. 3M has increased the dividend yield by 7.6%--continuing a 55 year history of dividend increases. They are now interested in repurchasing $7.5 billion worth of shares.
Management is also working on simplifying the business. In late January, 3M restructured its Canadian business -- an announcement that came after the firm announced that it beat top-line expectations by $220 million. It is also rich in cash, with a current ratio of 2.3 --above the 1.5 times peer average and the 1.8 times S&P 500 average. With no return on invested capital, however, the time has come for management to spend some of that cash on acquisitions that add synergistic value to the business.
At a respective 18.4 times and 15.9 times past and forward earnings, 3M is reasonably priced and in need of a catalyst. Analysts forecast 9% annual EPS growth over the next 5 years. I, however, find this much too optimistic, since the growth rate was only 2.4% in the past 5 years and there hasn't been a significant enhancement in innovation. Over the past 5 years, R&D has only increased by 16.7% -- an average of just 3.3%. If even selective R&D spending couldn't fuel a faster earnings growth, why should we have any more confidence in 3M at a premium 18.4 multiple (the 5-year average PE multiple is 14.9)?
GE and 3M both provide terrific diversity. However, sometimes, it is wiser to just diversify your portfolio through different sectors than to go through one company, which may be a prisoner to bureaucratic shortcomings. While both GE and 3M have done a lot to showcase a focus on innovation, the latter's expectations have set the bar comparatively high. For this reason, I recommend preferentially investing in GE.
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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. Think you can do better? Join us and write your own!