A stock market darling of the '80s and '90s, General Electric (NYSE:GE) lost some of its cachet over the past decade. Shares in the manufacturer have lagged the S&P 500's return by 100% during that stretch.
But lately, GE's management team has been refocusing and reenergizing (literally) the company's portfolio of businesses. A smart acquisition and banking spinoff could lead the market to reevaluate GE's long-term prospects. While it's no guarantee, shares of GE look poised to outperform for three important reasons:
Reason 1: GE made a huge power play
In the second-quarter of 2014, GE shook hands on a big merger focused around the power business of France's industrial outfit Alstom. GE paid a hefty sum – just shy of $17 billion – but walked away with an opportunity to become a more dominant player in the global turbine market.
Since scale really matters in the energy sector, the Alstom tie-up adds heft in areas where GE needed it most. For example, Alstom's heavy in geographies where GE has traditionally been light: The Paris-based company derives 85% of its revenue from outside North America and 80% outside of Western Europe. Likewise, Alstom will add 35% more capacity to GE's overall power generation business, and 75% of that capacity will come from steam turbines rather than gas.
Most importantly, this transaction has both short and long-term benefits for GE. Right off the bat, GE estimates Alstom will add about $10 billion of revenue in highly coveted growth markets. Down the road, the integration of Alstom is expected to provide GE with an additional $600 million in operating income and $1 billion in cost synergies by 2016. As my colleague Asit Sharma has pointed out, that would imply a return on investment of 12% on the Alstom assets, which towers over GE's 4.6% return on industrial assets in 2013.
The new GE is not one to make blockbuster acquisitions, but the Alstom merger aligns well with the company's goals and should greatly enhance the energy side of its portfolio, as I'll discuss under Reason 2.
Reason 2: GE's no longer a bank
The Alstom deal has broader implications because it helps GE reshape itself into the manufacturer that it wants to be (and once was). GE's in the process of pivoting away from banking, a step-by-step ordeal that just received a much-needed catalyst. Coupled with the recent spinoff of GE Capital's retail finance arm, it's almost a certainty these two moves will be received favorably by the market.
To understand why investors might reward GE's stock with a higher premium, think about these stakeholders as you might think of GE's customers. If GE's trying to do business with customers who are interested in jet engines, would it boast about its experience in lending? Probably not. Perhaps to the extent that it might help that customer with financing their purchase. But that's basically the only purposeful role for GE Capital going forward.
To continue with an analogy, however, if an investor is interested in buying shares of a manufacturing company, that investor's probably not fond of one that derives half of its income from banking. And that's where GE stood nearly 7 years ago.
With the addition of Alstom and separation of Synchrony Financial, GE's CEO Jeff Immelt expects that he will be able to boast about 70% of GE's earnings stemming from industrial operations by the end of this year. By 2016, their estimate increases to 75%.
This will come as a relief to investors who have been watching GE try to turn that corner for some time now. As I've noted before, with each step GE makes toward a more industrial-focused portfolio, the market tends to reward the stock with a more handsome valuation. That's why GE's price-to-earnings multiple has expanded by 29% since 2009.
The market's increasingly optimistic about GE's stock even as the company's moving from a higher margin banking business to lower industrial margins. In 2013, for example, GE Capital's segment margin stood at 18.7% versus 15.7% for the industrial and energy businesses.
But investors appreciate the fact that GE's sticking to what it knows best, which is manufacturing products. And in that arena, GE still has some ground to make-up relative to its peers: The industry's average P/E ratio stands at 19.6 versus GE's 17.7. But as GE's transition continues to take shape, expect that gap to close and bolster the stock price.
Reason 3: GE's poised to prosper from global growth
The final reason GE's stock could rise has to do with external factors that are moving in the right direction for the company. These are less near-term in nature, and relate more to positive developments that could take a decade to unfold.
With this in mind, let's take a step back and consider what GE lays out as its top priorities as a company: In its mission, GE's ultimate goal is to "build, move, power, and cure the world." That's a bold and admittedly broad statement, but we can see how a vision like this takes shape by zooming in on one industry, like power generation.
Consider GE's goal to power the globe. The company recognizes that the world is rapidly moving toward cities and will continue to do so. By 2030, the United Nations estimates that there will be 668 cities of at least 1 million residents, an increase of 36% over today's total of 488.
That sort of massive population growth in urban areas will radically shift the world's demand for energy – and most of it will come from developing countries. The International Energy Agency estimates, for example, that more than 90% of net energy demand growth to 2035 will arise from emerging economies.
These are exactly the types of places where GE's gaining traction through its purchase of Alstom, whose operations lie beyond GE's traditional U.S. and European strongholds. China, for example, is home to 20% of Alstom's installed global capacity, but the country generates only 4% of its power from natural gas today. What's more is the Energy Information Administration estimates that China's natural gas reserves could be 50% higher than that of the United States at 36.1 trillion cubic meters.
It comes as no surprise, then, that GE's aligning itself with trends that could have a big payoff for its bottom-line, and ultimately, shareholders. Combine sizable population growth with vast untapped resources, and a company like GE can create tremendous value in emerging markets.
The takeaway for investors
GE is making inroads in energy that are reshaping the company's portfolio, removing risks associated with banking, and translating to faster growth for a $146 billion behemoth. But energy's just one slice of the pie. As billions of citizens create a larger, global middle class, odds are they'll look to GE for additional needs, like transportation, air travel, and access to high quality health care.
There's reason to believe GE's early bets in these areas will pay off handsomely for investors.