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Give Immelt a chance
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December 14, 2001: 6:04 p.m. ET
GE's new CEO is laying the foundation for the stock's next sustained advance.
By Michael Sivy
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NEW YORK (CNN/Money) - Jack Welch would have been a tough act to follow under any circumstances. General Electric's superstar CEO had originally planned to retire in April. But he decided to hang on until the company's acquisition of Honeywell closed. Instead, the deal busted because of opposition by European antitrust regulators, and Welch had to leave on a sour note. Jeffrey Immelt finally took over in September, just four days before the terrorist attacks that deepened the recession. Since then, a variety of setbacks -- large and small -- have cast a pall over GE.
But investors may well be underestimating both Immelt and GE's stock, which is down almost 40 percent in the past 18 months. More than two-thirds of GE's earnings come from businesses that are doing well or are poised for an imminent upturn. The businesses that are more seriously depressed should recover by 2003. Earnings are expected to rise by at least 10 percent this year and next -- and then accelerate to their long-term growth trend of 13 to 14.5 percent.
GE's most embarrassing problem is of minimal financial consequence. The EPA has ordered GE to dredge 2.65 million cubic yards of sediment from the upper Hudson River. That cleanup is intended to remove potentially carcinogenic PCBs from the river that were introduced by GE's industrial waste prior to 1977. The cost of the dredging could total $500 million -- but GE can afford it.
Most of GE's (GE: up $0.60 to $37.65, Research, Estimates) businesses are cyclical, and the more serious issues from a financial point of view are those operations that are in a recession-induced downturn. The drop in advertising has hurt profits at NBC, which has decided to accept liquor advertising, something the networks have refused to do for decades. GE's aerospace businesses are suffering as well because of the deep slump now afflicting the airline industry. And other cyclical divisions, such as plastics, are depressed as well.
But all of those sectors should pick up next year, with the exception of aerospace, which may lag into 2003. Nearly 70 percent of the company's business, however, comes from operations that are currently doing well, including power systems, medical and financial services. The chief reason, in fact, that GE's earnings gains figure to be below par next year is that GE faces higher pension costs amounting to at least 5 cents a share.
Jack Welch stayed too long. The Honeywell deal was a flop. And the economy is bad. But Immelt is trying to position the company for the next upturn. The new CEO is scheduled to present his long-term plans to analysts next week, but on Friday the company underlined its confidence. The dividend was raised by 13 percent for the 26th year in a row and the budget for stock buybacks was increased. GE has used its abundant cash flow to repurchase more than 1 billion shares over the past seven years.
Despite the recession, GE's underlying earning power seems scarcely diminished. With growth potential of at least 14 percent a year and a 1.7 percent yield, the stock's total return should top 15 percent annually over the long term. Those prospects would justify a higher P/E than the stock's current 24 times estimated 2002 earnings, especially considering that GE is still one of the top companies in the world.
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