My bearish stance on General Electric
First, GE's financial services operations scare me. They have always been something of a black box to investors, yet drive a substantial portion of profitability. The finance operations do have a stable history, but the current turmoil afflicting credit markets could end up wounding the mighty GE. A look at the stock chart of the Financial Select Sector SPDR
GE's cash flow trends in recent years have also been murky -- reported net income has grown in the high single digits annually over the past five years, but operating cash flow has been uneven and on average hasn't moved much since 2002. Yet capital expenditure needs have risen steadily, leaving even less free cash for shareholder-friendly activities like dividend payments and share repurchases. We'll have a better read on how 2007 shook out once GE issues its annual 10-K in February, but if near-term history is any guide, cash generation won't be anything spectacular.
Finally, shares are currently trading near 52-week lows, but the general market malaise means there are plenty of compelling bargains competing for investor dollars. I just don't see GE as worthy of my capital as compared to other beaten-down peers.
For example, GE trades at 16 times trailing-12-month earnings. Motley Fool Inside Value recommendation 3M
GE also strikes me as just too big an enterprise to post the double-digit shareholder returns that investors became accustomed to when Jack Welch was at the helm.
Read the bull argument
My argument is solid, but it's not the only one to be made. Fool Jack Uldrich is the bull in today's Duel. Go read his argument and then come back here for my rebuttal.
GE is indeed operating at the forefront of fast-growing international markets and compelling product areas such as greener, renewable energy equipment and related technologies. But like any enormous company, GE's seemingly impressive expansion campaign will likely result only in high single-digit sales growth given the $171 billion annual sales that analysts expect it to post for 2007.
That's a substantial top-line base to grow from, and management's euphemistically stated goal is for "organic growth of 2-3 times GDP." It is also shooting for 10% annual earnings growth.
To me, these figures show that GE is finding it more and more difficult to leverage average sales growth into steady, double-digit increases in cash flow generation. Sure, shares now offer a decent 3.5% dividend yield, but that's not sufficient. The uncertainty in financial services could offset the enviable growth prospects that exist for GE in international and emerging markets.
The shares are definitely not overpriced at 14 times forward estimates, and Jack did point out that almighty GE used to trade at a hefty premium to the S&P 500. A long-term market multiple may in fact be more appropriate; CEO Jeff Immelt recently detailed that GE has traded at about 15 times earnings throughout its history.
I don't think that investors will lose money by going with GE, but I don't see a whole lot of upside either, given my near-term worries over how credit market volatility will affect GE's financial services businesses.
My concern is for the long term -- how will the company keep the bottom line growing with GE's modest top-line projections and near-term credit challenges?