How to Invest in Wind Power After the Tax Credit Croaks

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

Over the past half-decade, the federal Production Tax Credit has allowed domestic wind power companies to save roughly $20 billion a year, contributing to 75,000 jobs in total.  With a political deadlock in Washington, the PTC is set to expire by the end of this year, wreaking havoc on the industry at large. Despite these concerns, one energy titan can whether the storm. In addition to operations in the oil, natural gas, and water industries, General Electric (NYSE: GE) also manufactures wind turbines, but relies on 3rd party suppliers to produce many first-stage components.  If, say, 75% of these suppliers are unable to continue without government subsidies, GE will “end up with the best [companies] at the toughest time,” as VP of Renewables Vic Abate has so pertinently stated.

Now, General Electric has been able to leverage its size to become an important player (7.7% market share) in the global wind market as well, allowing it to maintain U.S. operations at a reduced level until pricing parity is reached between renewables and hydrocarbons (which is discussed in detail here).  It is expected that around half of turbine orders will come from abroad in 2013, as the company can lay claim to a $500 million project in Brazil and a similarly sized venture in wind-rich Ontario, Canada.

Since the recession, General Electric has seen its annualized revenues stall at a slower pace (-6.9%) than the diversified industrials industry average (-0.2%), and competitors like Siemens (NYSE: SI) at -1.7%, United Technologies (NYSE: UTX) at -0.9%, and Koninklijke Philips Electronics (NYSE: PHG) at -5.1%.  Not surprisingly, earnings also shrank during this time period, though by a larger percentage (-11.6%), and far below the industry average (8.1%), and the likes of SI (59.6%), UTX (3.9%), and PHG (-3.3%). Somewhat expectedly, it appears that the markets are overestimating these declines, as it is trading at a price-to-earnings ratio (15.7X) below its own 10-year historical average P/E (17.2X).  When growth is accounted for, shares are on the lower bound of a fair valuation, trading at a PEG ratio of 1.1; typically anything below 1.0 signals undervaluation.

From a cash standpoint, GE has grown its post-recession operating (31.9%) and free (19.2%) cash flows at impressive rates, though the company sports a price-to-cash flow ratio (6.8X) below its 10-year historical average (8.1X).  In fact, General Electric’s cash flows have historically traded at a 19% discount to those of the S&P 500 over the past decade.  This year, they appear cheaper, trading at a 24% discount.  Additionally, the stock trades at a PCFG ratio (computation is similar to the PEG ratio) of 0.6, furthering the undervaluation argument.

Earlier this July, the company beat the Street’s earnings estimates of $0.37 a share while reaffirming its year-end outlook.  Additionally, it was announced that the company was splitting its $50 billion energy business into three distinct sections – power & water, oil & gas, and energy management. The move is expected to increase efficiency, trim operating costs, and improve management structure.

Going forward, analysts are expecting it to finish 2012 with earnings of $1.55, up from the $1.29 it reported in 2011.  By 2013, EPS is expected to jump another 12.4% to $1.74.  If these estimates hold, fairly valued shares of GE should eclipse $26 a share by year’s end, with upside of $30 by next summer.  The stock currently trades in the $21 range.  WealthLift’s Sentiment Index rates GE as a strong buy, with over 90% of the community’s investors placing an “overperform” rating on the stock.

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