(Published by Bob Ciura on July 25)
Blue-chip stocks generally have a reputation for high-quality businesses, steady profits and reliable dividends.
While there is no exact definition for the term "blue-chip," we believe it is a company that has paid a dividend for 100 years and has a current dividend yield of at least 3%.
Companies with more than 100 years of dividends have proven business models, with the ability to navigate difficult economic conditions and adapt over time.
A 3%-plus dividend yield indicates a company cares about rewarding shareholders and offers an above-average yield.
There are dozens of stocks that fit these two requirements. You can see the full list of blue-chip stocks here.
General Electric Co. (GE, Financial) has a 3.7% dividend yield and has made dividend payments for more than a century.
Even though GE has had a rough start to 2017, its transformation is laying the groundwork for future growth. Combined with a high dividend yield, GE remains a blue-chip stock.
Business overview
GE is an industrial conglomerate. Its operating segments are as follows:
- Power (24% of revenue)
- Aviation (23% of revenue)
- Health care (16% of revenue)
- Oil and gas (11% of revenue)
- Renewable energy (8% of revenue)
- Transportation (6% of revenue)
- Energy connections and lighting (12% of revenue)
GE reported earnings per share of $1 in 2016, which was flat from 2015. The company’s adjusted EPS, which excludes certain non-recurring items, increased 14% in 2016 to $1.49.
The company is struggling with lower commodity prices, which have weighed on its oil and gas business. Segment revenue declined 22% in 2016.
Weak commodity prices will continue to be an overhang for 2017. Because of this, GE is aggressively cutting costs to keep margins steady.
Source: 4Q 2016 Earnings Presentation, page 6
This helped the operating profit margin rise 10 basis points in the fourth quarter.
Plus, the company can offset declines in oil and gas revenue with growth in other areas.
For example, GE saw strong growth in renewable energy and power, which grew revenue by 44% and 25% in 2016 respectively.
GE is also in the process of a management transition.
CEO Jeff Immelt recently stepped down. John Flannery, who is currently president and CEO of GE’s health care business, will step into the role on Aug. 1.
GE is facing a heightened level of uncertainty right now, which has kept a lid on the stock this year.
Investors should keep in mind the fundamentals of the company remain healthy, with growth potential going forward.
Growth prospects
GE has enjoyed strong results to start 2017.
Over the first half of the year, however, industrial revenue declined 1% due to currency exchange rates.
Excluding the impact of foreign exchange, GE’s organic revenue increased 4% through the first six months of the year. Organic operating profit increased 11% in the same period.
GE ended last quarter with a $327 billion backlog. Orders for equipment and services rose 5% last quarter.
Source: Q2 Earnings Presentation, page 3
This indicates demand for GE’s products and services remains strong.
In addition, GE is in the process of a major restructuring. It is gradually divesting its massive financial segment, GE Capital. The company has already sealed $192 billion of deals to sell off its financial businesses.
According to GE, the "new" GE Capital will be much less risky than the previous entity.
GE Capital had reported significant losses in recent years. GE Capital lost $8 billion in 2015 and another $1.2 billion in 2016.
The end result of this process is GE will derive most of its earnings from its industrial activities.
This is a positive step for the company as its industrial operations are the main driver of future growth.
Source: 2017 Shareholder Meeting, page 4
It should also help GE hold up better during the next recession, since GE Capital nearly brought the entire company to the brink of collapse during the Great Recession.
For 2017, GE expects organic revenue growth of 3% to 5%. Adjusted EPS are forecasted to range between $1.60 and $1.70, which would represent 7% to 14% growth in 2017.
Competitive advantages and recession performance
GE’s main competitive advantage is its massive size. The company has a market capitalization of $220.6 billion.
As a result, GE benefits from economies of scale, which help support its profit margins. This gives the company the financial strength to invest heavily in research and development:
- 2014 R&D expense of $4.2 billion.
- 2015 R&D expense of $4.2 billion.
- 2016 R&D expense of $4.8 billion.
Strong R&D spending fuels innovation and provides GE with an industry-leading brand.
According to Forbes, GE is the 11th most valuable brand in the world.
One of the downsides of operating in the industrial sector is GE is not resistant to recessions. The company was hit extremely hard during the Great Recession:
- 2007 EPS of $2.20.
- 2008 EPS of $1.78.
- 2009 EPS of $1.03.
- 2010 EPS of $1.15.
Fortunately, GE steadily recovered after the recession ended.
Valuation and expected total returns
Today, GE stock trades for a price-earnings (P/E) ratio of 17. This is a fairly low valuation for a company with a strong brand and highly profitable business.
The S&P 500 Index trades for an average P/E ratio of 25. In addition, these are the P/E ratios of several of GE’s peers within the industrial sector:
- 3M (MMM, Financial): 25
- Emerson Electric (EMR, Financial): 23
- Illinois Tool Works (ITW, Financial): 23
- Dover (DOV, Financial): 21
It is understandable why GE would have a lower valuation multiple than its peers given its relatively higher uncertainty.
If GE’s transformation is successful, however, the company could earn a higher valuation multiple down the road.
The company is being weighed down by the uncertainty associated with its restructuring and management shakeup, but the underlying business is growing.
A higher P/E ratio would generate significant shareholder returns.
In addition, GE will generate returns from earnings growth and dividends. A reasonable breakdown of future returns is as follows:
- 3% to 5% revenue growth.
- 1% margin expansion.
- 2% share repurchases.
- 3.7% dividend yield.
Under this scenario, total returns would reach approximately 9.7% to 11.7% per year.
Cash returns will be a significant driver of future shareholder returns. The company expects to use $11 billion to $13 billion for share repurchases this year alone thanks to the proceeds of the GE Capital divestments.
GE also has an attractive 3.7% dividend yield. While the company has paid a dividend for over 100 years, its dividend history is volatile.
The company cut its dividend in 2009 by 68%, which was its first dividend reduction since 1938. Again, this was due to the damage GE absorbed during the Great Recession.
Of course, GE has dramatically improved its financial position since the recession.
The current dividend appears to be sustainable as GE has a dividend payout ratio of 64% based on 2016 adjusted EPS.
While the company is in a much better position now, investors should keep in mind it is not immune from recessions.
Final thoughts
The uncertainty associated with GE’s changing management and business restructuring have caused the valuation multiple to contract.
The good news is GE’s 20% year-to-date decline could be an opportunity.
The stock now offers a discounted valuation as well as a nearly 4% dividend yield. Additionally, the company has solid growth prospects up ahead.
As a result, in the coming years GE stock could prove why it is widely considered to be a blue-chip dividend payer.
Disclosure: I am not long any of the stocks mentioned in this article.
