-by Alec Mazo
In the last edition of GSB Reporter I provided a quick value investment thesis for two companies: Cummins and Baidu. This time I want to build on those companies to demonstrate two more ideas that could begin to diversify a value portfolio if purchased at the right price: GE and Boeing.
1. GE (GE) – US economy barometer & dividend appreciation potential
Sloan – Mike Kelly Mile Kelley started his career with GE in 2000 as a commercial credit analyst for GE Commercial Finance in Chicago. He later completed GE’s prestigious Corporate Audit Staff program as a manager, served as a finance manager with the Oil & Gas division in Florence, Italy and most recently was in the Corporate Business Development team in Fairfield, CT working in Global M&A and corporate strategy.
I think GE ($204B cap) can be considered a barometer of the American economy even though 50% of GE’s revenues are generated outside of the United States. GE is a well-diversified industrial global conglomerate. GE positions itself to be the best performer in all of its industries and it enjoys a wide economic moat because of its resources and expertise in each field. I will omit the numerous business segments GE represents, but this information is easily available online. In a tough economic environment, the company can have several underperforming business segments, yet still manage to produce decent profits.
Financially, GE delivered around 10% avg net income over the last 10 years. GE’s ROE since 2001-2008 has been hovering around 18% but has dipped since 2008 to around 10% due to the recession and GE Capital troubles. ROE in GE’s case is magnified as a result of leverage, its’ long term debt and other liabilities are approximately $400B while its equity is $125B. However, considering the sizable $465B current asset position vs $203B current liabilities, liquidity is not an issue. DCF with 8% annual owner’s earnings growth, 12% discount rate, and 3% terminal growth rate yields intrinsic value of $26.26 based on $11.8B owner’s earnings (Net Income + Depr – CAPEX + special charges). The margin of safety is 27% to the current $19.39 share price.
GE has increased the dividend payout from $6.3B to $12.4B in the period from 2001-2008, and then scaled back to $6B in 2011. It is a reasonable assumption that when the macro economy stabilizes, GE will drive the dividend to its’ normalized levels which would represent 8-10% yield based on current price (currently 3.51% dividend). GE is a good company to own for income investors looking for exposure to the US and global economy.
2. Boeing (BA) – aerospace
Sloan – Alex Zakroff leads the Global Navigation Services (GNS) organization for Jeppesen, an information services company and wholly-owned Boeing subsidiary whose core products include the provision of navigation information to aviation and maritime customers worldwide. As Vice President, Alex holds overall responsibility for operational execution supporting Jeppesen’s core navigation products, as well as for leadership and staff development, process improvement and executive communication.
The company operates in two segments: commercial and defense. The first long-awaited and delayed 787 Dreamliners were finally delivered to Nippon Air last quarter. The company delivers between 480-490 commercial airplanes every year, with revenue projections of $68B and operating margins 8-10%. Boeing and Airbus still effectively operate as a duopoly of airplane manufacturing, providing them with economic moats based on their relationships with key customers. However, this customer supply chain will have more options as Bombardier, Mitsubishi, United Aircraft, and COMAC enter the market. The US defense segment spending related to Boeing’s expertise will likely drop as a result of defense spending cuts and Lockheed’s F-35 contract. As a result, defense related revenues will deteriorate from the current 50% of total revenues.
Air travel has consistently grown at 1.5x GDP and developed countries will continue to replace old planes with newer, more efficient models. Operating economics incentivize upgrades, though airlines often use planes for over 25 years. Boeing estimates global demand of 33,500 commercial units in the next 20 years, totaling over $4 trillion. As long as Boeing continues with innovation and reliable customer service, it should be able to maintain a competitive moat against new entrants. Boeing production plans include increasing 737s from current 31.5 to 38 units per month by 2013, 777s from current 5 to 8 per month by 2013, 787s from 2 to 10 units per month by 2013. Margins will not improve immediately with increased production due to 787 delays.
Boeing’s total backlog is $332B, or 5 times annual sales. However, in 2008 the company experienced a year with negative equity partly as a result of the macro economic conditions and partly because of the write downs due to production delays. The company operates in a highly capital intensive business; it is highly leveraged and any operating miscues could be costly. Net profit margins between 5-6% could be considered a good year. Boeing’s EPS numbers in the last 10 years have been wildly inconsistent, fluctuating between $.61 and $5.28, the troughs becoming apparent during and shortly after recession periods. However, I think we can safely assume that Boeing will not go out of business soon considering that the United States government signals the high quality of the firm when the President uses a 747 and government officials fly on 737s. Boeing’s fair value of $78.31 is close to the current price of $75.72, assuming a 4.8% owner’s earnings growth rate, 9% discount and 3% terminal growth. The margin of safety is 6%. Its’ backlog gives investors some visibility for years to come and market price fluctuations could prove attractive entry points if the price could drop to a 30-40% margin of safety.
alecmazo 