-
North America Equity Research 16 March 2010
General Electric Co.
Overweight GE, GE US
Locked and Loaded: The Case for GE as a Momentum Play
Price: $17.29
Price Target: $22.00
Multi Industry & Electrical Equipment
C. Stephen Tusa, Jr CFAAC
(1-212) 622-6623 [email protected]
Phil Gresh, CFA (1-212) 622-4861 [email protected]
Drew Pierson (1-212) 622-6627 [email protected]
J.P. Morgan Securities Inc.
9
12
15
18
$
Mar-09 Jun-09 Sep-09 Dec-09 Mar-10
Price Performance
YTD 1m 3m 12mAbs 14.3% 7.8% 9.8% 79.0%
General Electric Co. (GE;GE US) 2009A 2010E
(Old)2010E
(New)2011E
(Old)2011E
(New)2012E
EPS - Recurring ($) Q1 (Mar) 0.26 0.15 Q2 (Jun) 0.26 Q3 (Sep)
0.22 Q4 (Dec) 0.28 FY 1.03 0.92 1.00 1.15 1.30 1.62Source: Company
data, Reuters, J.P. Morgan estimates.
Company Data Price ($) 17.29Date Of Price 15 Mar 1052-week Range
($) 17.52 - 9.26Mkt Cap ($ mn) 183,533.35Fiscal Year End DecShares
O/S (mn) 10,615Price Target ($) 22.00Price Target End Date 31 Dec
10
See page 23 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in
its research reports. As a result, investors should be aware that
the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report
as only a single factor in making their investment decision.
We believe that, for the first time in over 10 years, the pieces
are in place for earnings upside, a key to moving GE from value to
momentum.
GECS not just a credit story . . . Investor focus remains on
credit losses, an intuitive factor that moves with the economy. We
believe losses are peaking and should begin to decline in mid 2010,
and depending on the economy, we could see a rapid decline to
normal levels in 2013, which would provide an estimated tailwind of
$0.90 per GE share.
. . . as NIM locked and loaded, on the cusp of improvement in
years ahead . . . Less obvious are the dynamics around portfolio
margin, where GE benefits from cheap credit and limited
competition. Guidance currently calls for a margin of ~5% in 2010,
up only 40 bps. We see upside to this margin in 2011, and, by 2013
a potential ~$3B of tailwind.
. . . driving upside to GECS earnings. Putting it all together,
we estimate GECS can do $2B in 2010 and $4B (more fully taxed) in
2011 versus 2010 guidance of ~$1.75B. The bottom line is that we
still see normalized GE earnings of ~$2 in 2013, though the
trajectory, especially at GE Capital, is likely to be more front
end loaded, a positive.
Industrial: services backlog robust, especially at Aviation
where macro environment is improving . . . The 10K showed a Tech
Infrastructure services backlog scheduled for delivery stronger
than expected at $11.9B vs. $9.2B estimated a year ago, mostly from
Aviation, a positive. Peer comments support upside in the highly
profitable aircraft services business (~15% EPS).
. . . while other businesses stable, and slowly turning. Energy,
Healthcare, and even Transportation have moved from the
deteriorating camp to "stable." We see all-in Industrial profit
growth at a conservative 10% in 2011.
All in, upside vs. Street looks possible for first time in 10
years. We now see the potential for a beat in 2011. Our new 2010
number is $1.00 (Street $0.99), with 2011 moving to $1.30 (Street
$1.20). Keep in mind that GE has missed sell-side FY2 expectations
every year since 2000.
GE remains our top pick, momentum dynamics not discounted. GE is
still considered a value play by most, and we agree at 13x 2011E
EPS. However, we believe positive revisions would move GE decidedly
into the momentum camp. Philosophically, we view positive earnings
revisions as the ultimate catalyst for share price upside.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Earnings Momentum Slowly Building We believe that the pieces are
in place for earnings upside one year out, a key to moving GE from
cheap with no catalyst into the momentum camp. The key here, as
always, is GE Capital, at which we continue to see dramatic
earnings tailwind from current levels to normalized on the back of
lower losses and expanding margins, which offsets a decline in
earning assets and a rising tax rate. We are also conservative on
Industrial, though there are several data points that suggest we
may be too conservative. Most notably, the pickup in air traffic
and improving health in the airline industry, along with favorable
timing around shop visits at GEAE suggest there could be some
upside as soon as 2010. At 15-20% of GE Industrial profits, this
business can move the needle. The bottom line is that we still see
normalized GE earnings of ~$2 in 2013, though the trajectory,
especially at GE Capital, is likely to be more front end loaded, a
positive. Keep in mind that its been almost a decade since GE beat
FY2 estimates as they stood at the beginning of FY1, and a beat of
next years number would be the first time in CEO Immelt's tenure
that we see an upward revision.
Table 1: Actual EPS Results vs. Initial FY2 Estimates for GE YOY
Beg. Year Diff. Vs. Actual % Chg. FY2 Est Actual
2001 1.41 10% 1.42 -1% 2002 1.51 7% 1.74 -13% 2003 1.56 3% 1.83
-15% 2004 1.59 2% 1.77 -10% 2005 1.72 8% 1.78 -3% 2006 1.99 16%
2.04 -2% 2007 2.20 11% 2.26 -3% 2008 2.20 0% 2.49 -12% 2009 1.03
-53% 2.43 -58% 2010E initial 1.10 2010E standing 1.00 2011E 1.20
??
Source: Bloomberg, J.P. Morgan estimates
Looking at the bridge for 2011 in more detail, Street estimates
of $1.20 look attainable and probably too low on lower
provisions/restructuring along with any reasonable pickup in
Industrial. First, on non-fundamentals, we model restructuring
returning to a normalized level, along with some carryover benefits
from 2010 actions, a net $0.06 help. Industrial businesses should
recover in 2011, as we assume 10% segment profit growth after a
roughly flat 2010, adding $0.07. The rest of the tailwind comes
from Capital Finance. This includes ~$3.5B ($0.33), partially
offset by higher taxes, while other dynamics (including the
expansion in NIM) help by $0.11.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Table 2: GE Earnings Bridge $mm except per share data
09 Actual 10E JPM 11E JPM Notes Beginning EPS 1.79 1.03 1.00
Pension 0.00 (0.07) 0.00 Corporate, x-pension/rstrng (0.05) 0.04
0.00 Restructuring spend (0.01) 0.04 0.04 $500mm lower per year
Restructuring saves 0.05 0.04 0.04 $500mm/yr carryover in
Industrial Industrial Gains/Impairments 0.01 (0.01) 0.00 Interest
0.05 0.00 0.01 Tax Rate 0.00 (0.00) 0.00 Share Count (0.05) (0.00)
0.00 Base EPS 1.78 1.05 1.09 Industrial Price/Cost 0.09 0.02 0.00
Industrial Volume/Mix (0.24) (0.09) 0.05 GE Capital (0.60) 0.02
0.17 Provisions (0.32) 0.13 0.33 Tax 0.14 (0.13) (0.27) NIM &
Other (0.42) 0.02 0.11 Final EPS 1.03 1.00 1.30 Prior Year
Industrial Sales 113,357 104,304 102,850 + Acquisitions 0 0 0 +
Currency 0 1,000 0 + Organic (9,053) (2,454) 5,995 = This Year
Industrial Sales 104,304 102,850 108,845 Organic Growth -8% -2% 6%
Implied $ Profit Incr/(Decr) (3,399) (1,307) 705 Implied Incr/Decr
Margin 38% 53% 12%
Source: Bloomberg, J.P. Morgan estimates
So, after being below consensus for a long time, we are raising
numbers, bumping 2010 in line with the Street, but establishing
2011 and 2012 numbers that are both ~$0.10 above the Street. While
we acknowledge that $0.10 of upside is not that exciting at face
value, we see a few levers including better industrial performance
and a quicker ramp down in provisions that could drive further
upside. In the end, however, as is most often the case with GE, the
direction is just as important as the magnitude, especially in the
context of the revision history for the last 10 years, which has
set a low bar for expectations and most certainly impacted the
valuation. This brings us to our next point on the stock.
Figure 1: We See Upside to Consensus in 2011 and Beyond EPS
1.001.20
1.51
1.00
1.30
1.62
0.50
0.75
1.00
1.25
1.50
1.75
2010E 2011E 2012E
Consensus JPM
Source: Bloomberg, J.P. Morgan
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
GE is still considered a value play by most, and we agree at 13x
2011E EPS. However, we believe positive revisions would move GE
into the momentum camp. Philosophically, we view positive earnings
revisions as the ultimate catalyst for share price upside, and we
remain OW on this basis. Our $22 Dec 2010 price target is based on
12x our normalized (2013E) EPS of $1.80, an in-line multiple with
the group target. This is reinforced by a sum of the parts analysis
on 2011E which has the Industrial business at 18x, a 20% premium to
our group average EPS, and a recovery to just 0.7x book value for
GECS. In the analysis below, we start with GECS, which remains the
most important lever in the story.
Table 3: Valuation Continues to Look Favorable FY11E EPS
Multiple Per Share
Industrial EPS 0.95 18.0 17.05 BV/share Multiple Per Share
GECS Implied 6.60 0.0 0.24 Current Stock Price 17.29
FY11E EPS Multiple Per Share Industrial EPS 0.95 18.0 17.05
BV/share Multiple Per Share GECS 6.60 0.7 4.95 Price Target
22.00
Source: Bloomberg, J.P. Morgan estimates
GECS: Ramp to Normalized Could Be More Front End Loaded GECS has
seen the greatest level of earnings impairment, a headwind to GE
EPS of $0.50+ from peak to trough, and the prevailing view is that
(1) losses will remain stubbornly high, while (2) a decline in the
asset base will make earnings growth a challenge. We disagree on
both fronts and continue to see a pathway to significantly higher
normalized earnings, through a combination of lower losses and
better margin, despite a lower asset base. With better data points
on credit performance as well as portfolio margin, we are growing
more confident in the outlook but believe the ramp could be more
front end loaded than we initially assumed, a positive and key to
the 2011 earnings momentum story. The bridge below shows the
building blocks of how we get to our 2011 number from the 2009
base.
Table 4: GECS Earnings Bridge $mm except margin data
2009 2010E 2011E Portfolio CV 32,748 32,218 32,945 Portfolio
Margin 6.3% 6.8% 7.4% Provisions (10,928) (9,517) (5,977) Other
expenses/gains/impairments (24,028) (23,185) (22,818) GECS Pretax
income (2,208) (484) 4,151 Taxes 3,829 2,484 (415) Net income 1,621
2,000 3,736
Source: Company reports, J.P. Morgan estimates
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Charge-Offs Likely Putting in a Peak, and Provisioning Still a
Major Earnings Lever Credit improvement and a related ramp down in
provisions is a more visible tailwind going into 2011, but we
continue to believe theres room for surprise just how quickly
provisions could ramp down from the peak. Macro indicators,
industry data, and comments from financial peers all suggest that
charge-offs are at or near peak, something that should become clear
at GE as soon as the 1Q earnings call. GEs charge-offs (the actual
loss experiences in the portfolio) have remained flat for two
consecutive quarters, and while guidance remains for
provisions/impairments to be flat in 2010, management has already
given indications that next year could be better. This includes (1)
commentary in the 4Q earnings slides that capital finance is
positioned for upside in 2010, and (2) CEO Immelts annual
shareholders letter published last week, in which GE believes that
non-earning assets have peaked, furthering the view that provisions
should drop on a dollar basis in 2010. The bottom line is that the
peak in losses looks to be coming sooner than many may have
expected, and a lower loss base for 2010 could carry through to
earnings upside in 2011. Keep in mind that the mix of the portfolio
in the out years will be more heavily weighted toward lower loss
commercial businesses, another reason why assuming the previous
normal may be too pessimistic and making our out-year model look
more conservative.
Macro data turning, while charge-offs look to be bottoming as we
speak We have always believed that a trough in macro trends
portends a peak in charge-offs, something that we believe is
playing out now. As an illustration, we plot industrial production
growth versus charge-offs for all consumer & commercial loans
at FRB chartered banks what is notable is that in the last two
recessions, the peak in charge offs came within a few quarters of
the IP trough (which came in mid 2009). While 4Q charge offs for
total loans and leases ticked up slightly in 4Q (mostly real estate
driven), that may well prove to be the peak given historical
relationships and the rapid improvement elsewhere in the
economy.
Figure 2: Industrial Production Recovery Has Historically Led
Improvement in Bank Charge-Offs Industrial Production (Y/Y) FRB
Total Loans & Leases (1 % Charge Off Rate)
-15%
-10%
-5%
0%
5%
10%
85Q1
86Q1
87Q1
88Q1
89Q1
90Q1
91Q1
92Q1
93Q1
94Q1
95Q1
96Q1
97Q1
98Q1
99Q1
00Q1
01Q1
02Q1
03Q1
04Q1
05Q1
06Q1
07Q1
08Q1
09Q1
10Q1
0
97.097.598.098.599.099.5100.0
Total Loans & Leases (1 - chargeoff rate) Est. IP Grow
th
Source: FRB, J.P Morgan estimates.
Notably, according to FRB data, charge-offs in many verticals
like C&I loans and consumer installment credit appear to have
already peaked in 3Q. This is not surprising in the context of
lending standards, which are now actually loosening for both
commercial and consumer loans, typically a bullish sign for credit.
Historically
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
charge-offs have peaked 12-18 months after a peak in lending
tightening, which came in 3Q/4Q of 2008.
Figure 3: C&I Charge Offs Have Peaked, Lending Standards Are
Now Being Eased . . . Net % Tightening, C&I lending standards
C&I Loans Annual Charge-Off Rate
-40-20
020406080
100
1Q90
1Q92
1Q94
1Q96
1Q98
1Q00
1Q02
1Q04
1Q06
1Q08
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Charge Offs Net % Tightening
Source: FRB, J.P. Morgan estimates
Figure 4: . . . And Consumer Lending Shows the Same Dynamics
Consumer Installment Lending Standards (% tightening) Consumer %
Charge-Off Rate
-50-30
-10103050
85Q1
87Q1
89Q1
91Q1
93Q1
95Q1
97Q1
99Q1
01Q1
03Q1
05Q1
07Q1
09Q1
0.00
2.00
4.00
6.00
8.00
Consumer loan charge-offs Cons Inst. Standar
Source: FRB, J.P. Morgan estimates
Fed charge-off data for total loans and leases has historically
been a good indicator for GE, per the chart below, given the mix of
commercial and consumer assets. In fact, while GE charge-offs have
generally moved directionally with the macro data, the peak in
losses has been less severe than we had originally thought based on
historical relationships. It is interesting to point out that we
had previously modeled GECS charge-offs to peak at close to 3%,
which now appears to be too conservative.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Figure 5: GECS Charge-Offs Leveling off with Macro Data . . . GE
Charge Offs as % of Avg Receivables FRB Annualized Charge Offs -
Total Loans & Leases
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
1Q09
2Q09
3Q09
4Q09
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
FRB - All Loans & Leases GE
Source: FRB, J.P. Morgan estimates.
Figure 6: . . . And Significantly Lower Than Our Previous
Expectations GECS Charge Offs, % of Rec FRB Annualized Charge Off
Rate, Total Loans & Leases
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
1Q09
2Q09
2009
E20
10E
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
FRB Total Loans & Leases GE
Source: FRB, J.P. Morgan Estimates.
Comments from Delinquency Data Stabilizing Across Most Verticals
Drilling a level deeper beyond just the macro data, a look at more
recent releases from major banks and other financial players
further illustrates the signs of improvement. What is clear based
on comments from a recent financials conference is that charge
off-trends continue to improve, in some cases ahead of previous
guidance. Most of these companies believe that charge-offs either
peaked in 4Q or that they will do so in 1Q.
Table 5: Financials - Summary of Credit Commentary from Recent
Conference Company Date Highlights of remarks STI 3/10 Expects 1Q
charge-offs flat w/ 4Q versus previous guidance of a q/q increase
RF 3/10 Credit cycle moderating, NPA formation slowing with
encouraging signs on credit front ZION 3/10 Says NCOs flat to
slightly lower in 1Q (in line w/ previous guide) USB 3/10
Charge-offs will increase q/q but near an inflection (in line w/
previous comments) FITB 3/11 Charge-offs to fall few hundred
million q/q in 1Q SNV 3/11 1Q credit metrics to remain similar to
4Q; 2Q to improve; 2010 provisions and NPAs to decline COF 3/11
Domestic charge-offs to peak in 1Q
Source: Company reports
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Looking at industry data from a few different verticals,
starting with equipment monthly data from ELFA, shows that
delinquencies and charge-offs look to have peaked in 3Q09. This is
a significant read through for GE, which has ~$60B of exposure
here. Similar to macro data around lending standards, credit
approval ratios bottomed in 2Q09 and have since risen, a positive
leading indicator. This all supports recent data from GE, which saw
delinquencies improve in 4Q.
Figure 7: ELFA 30+ Day Delinquencies
0%
1%
2%
3%
4%
5%
6%
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
Source: Equipment Leasing and Finance Association
Figure 8: ELFA Charge-Offs
0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
Source: Equipment Leasing and Finance Association
Figure 9: ELFA Credit Approval Ratios
55%
60%
65%
70%
75%
Feb-
08
May
-08
Aug-
08
Nov-
08
Feb-
09
May
-09
Aug-
09
Nov-
09
Source: Equipment Leasing and Finance Association
Figure 10: GE Equipment Financing Managed Delinquency
0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
Source: Company Reports
Elsewhere, for C&I loans more broadly, the theme across much
of 4Q earnings season were modest increases in NPLs and charge
offs, but at a slower rate of growth. In fact, while FDIC-member
banks saw another move up in charge-offs (2.67% in 4Q versus 2.64%
in 3Q, 2.43% in 2Q), non-earners actually moved sequentially lower
(3.44% versus 3.57% in 3Q). FRB data suggests that charge-offs
peaked in 3Q, while commentary from several banks, including USB,
suggests that a charge-off peak comes in 1H. Bottom line, we would
expect C&I losses to lag given that they are generally later
cycle, but a peak looks to be within sight.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Figure 11: C&I Loans Delinquencies/Non-Earners
0.0%1.0%2.0%3.0%4.0%5.0%6.0%
1Q84
1Q86
1Q88
1Q90
1Q92
1Q94
1Q96
1Q98
1Q00
1Q02
1Q04
1Q06
1Q08
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Non-Earners 30 Day Past Due
Source: FDIC Quarterly Banking Profile
Figure 12: C&I Loan Charge-Offs
0.0%0.5%1.0%1.5%2.0%2.5%3.0%
1Q84
1Q86
1Q88
1Q90
1Q92
1Q94
1Q96
1Q98
1Q00
1Q02
1Q04
1Q06
1Q08
Net Charge Offs
Source: FDIC Quarterly Banking Profile
On GEs global mortgage exposure, new disclosure beginning in
2009 makes it possible to follow the various regions more closely.
The risk from a loss perspective is the subprime exposure in the UK
($21B of the $59B in total mortgages). Recent data shows that
delinquencies and non-earners have leveled off since 2Q/3Q,
supporting GE's view that loss provisions could be lower here than
in 2009.
Figure 13: GE Mortgage 30+ Day Delinquencies
13.3%13.4%13.2%11.8%10.6%
25.2%25.8%25.9%21.0%
23.7%
0.0%5.0%
10.0%15.0%20.0%25.0%30.0%
4Q08 1Q09 2Q09 3Q09 4Q09
Total Mortgages UK
Source: FDIC Quarterly Banking Profile
Figure 14: GE Mortgage Non-Earners
5.5% 6.8%7.8% 7.8% 7.7%
14.1%11.0%
15.8% 16.1% 15.6%
0.0%
5.0%
10.0%
15.0%
20.0%
4Q08 1Q09 2Q09 3Q09 4Q09
Total Mortgages UK
Source: Company Reports
Finally, the Commercial Real Estate book remains a challenge,
though we dont believe this to be news at this stage in the cycle.
We expect this to worsen in the coming quarters, but at only 13% of
the receivables base it is not enough to outweigh improving trends
across other areas in the portfolio. We model an increase of RE
provisions to $1.65B in 2010 and $2.35B in 2011 from $1.44B in
2009.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Figure 15: FDIC Member Commercial Real Estate Loan Performance %
Non Earners % Charge Offs
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%
Q191
Q192
Q193
Q194
Q195
Q196
Q197
Q198
Q199
Q100
Q101
Q102
Q103
Q104
Q105
Q106
Q107
Q108
Q109
0.0%
1.0%
2.0%
3.0%
4.0%
Non-earners Charge offs
Source: FDIC
Figure 16: GE Real Estate Charge-Off Rate (Annualized)
0
100
200
300
400
500
2005 2006 2007 2008 1Q09 2Q09 3Q09 4Q09
Source: Company reports
Longer Term, Mix of Business Should Be Beneficial to Loss Levels
If we assume that credit troughs near term, then we need to begin
to dial in expectations for the out years. Our previous estimate is
for provisions to move from the standing 2009 peak of $10.9 B to
~$3B, which is the same level the company saw in 2005 on a similar
base of receivables ($290B). It is notable, however, that the mix
of the assets this time around should be much more favorable, with
65% in more secure, commercial business versus the previous level
of 55%. The table below illustrates these dynamics and how the
different mix can be more positive. We have lowered our estimate
from $3B to $1.5B to better reflect this dynamic.
Figure 17: Mix Should Lean More Towards Commercial
55%
65%
45%
35%
0%
10%
20%
30%
40%
50%
60%
70%
2005 2013E
Comm'l
Consumer
Source: J.P. Morgan estimates, Company data.
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North America Equity Research 16 March 2010
C. Stephen Tusa, Jr CFA (1-212) 622-6623
[email protected]
Figure 18: Which Represents a Minority of 2009 Provisions, in
Line with Historical Patterns
35%
65%
79%
0%10%20%30%40%50%60%70%80%90%
Comm'l Consumer Hist Consumer Av g
Source: Company data.
We continue to assume structurally higher reserves, while
charge-offs could still prove better than our model, meaning a
quicker ramp down in provisions The bottom line on credit is that
even assuming a modest increase in charge-offs in 2010 (far from a
given as charge-offs may have already peaked), we believe
provisions can ramp down dramatically and still get to structurally
higher loan loss reserves. Our model shows the ending reserve build
reaching ~3.9% by the end of 2012, or almost twice the companys
historical average reserve of 2.25%.
Table 6: We See Provisions Dropping While Reserves Build $ in
millions
2009E 2010E 2011E 2012E Beginning Reserve 5,325 8,105 9,796
10,582 Provisions 10,928 9,517 5,977 3,730 Net Charge offs 8,148
7,576 5,190 3,077 Ending Reserve 8,105 9,796 10,582 11,235
% of Receivables Beginning Reserve 1.41% 2.35% 3.03% 3.45%
Provisions 3.02% 2.85% 1.90% 1.25% Charge Offs 2.03% 2.27% 1.65%
1.03% Ending Reserve 2.35% 3.03% 3.45% 3.87% Source: J.P. Morgan
estimates.
Net Interest Margin, a Key Driver GEs NIM has been near historic
lows in 1H09, driven down by the pre-funding of 2010 liabilities,
sluggish commercial loan demand, the reduction in commercial paper
(a negative for mix of interest expense), as well as the low
yielding business put on at the peak of the most recent credit
boom. We expect this to normalize over the next two years as
pre-funded debt works its way into interest-bearing assets and
better pricing on recent deals begins to flow through. All in, we
see ~190bps of cumulative improvement in NIM from 2009 levels, the
bulk of which should come in 2010 (+60bps y/y) and 2011 (+50bps
y/y). Below we show net interest margin historically, which fell
throughout the last cycle. As background, the definition includes
revenues from operating leases as well as PP&E (mostly leased
equipment), minus interest expense and D&A.
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Figure 19: GECS Net Interest Margin Including Operating
Leases
0%
2%
4%
6%
8%
10%
12%
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
1Q09
2Q09
3Q09
2009
E20
10E
2011
E20
12E
2013
E
Source: Company reports, J.P. Morgan estimates.
At a high level, the theme here is that GECS is well positioned
to take advantage of its currently low cost of capital and provide
scarce but needed capital to the middle market customers and
consumers. In essence, this is an arb between those two markets and
the spread is quite wide. The charts below show GE's debt spreads
next to the NFIB survey of small business, showing that GE's cost
of capital continues to improve, while availability from
competitors remains scarce, a positive for near-term pricing.
Figure 20: GE Borrowing Spreads Back to Pre-Crisis Levels . . .
GE 10 year debt, spread to Treasuries
-100200300400500600700800
Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10
-100200300400500600700800
Source: J.P. Morgan
Figure 21: . . . While Small Business Credit Availability Still
Tight NFIB Availability of Loans Index
-20
-15
-10
-5
0
Apr-0
8
Jul-0
8
Oct-0
8
Jan-
09
Apr-0
9
Jul-0
9
Oct-0
9
Jan-
10
Source: NFIB
A Deep Dive into Capital Finance portfolio margin We take the
analysis a step further below, using information provided by GE
around the mix of collections/originations and related returns to
model the progression of higher yielding rolling on to the book. We
somewhat reluctantly use the GE definition of portfolio margin or
"contributed value" as the driver, given that is the information
that the company has provided. We start by describing the
definition and how that differs from the NIM reported in the GECS
filings. We then model out our view around collections and
originations to illustrate the positive mix impact. This is key to
our model as it adds an incremental ~$2B versus the 2009 base.
As background, GE has recently begun disclosing data around
portfolio margin, a concept similar to the above definition of NIM,
though the complexities of GEs
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calculations make it somewhat difficult to interpret at face
value. In the numerator is contributed value (CV), which is total
revenues less interest expense (both on a Capital Finance basis,
from the GE 10Ks). This is divided into what GE calls average net
investment (ANI), or a trailing 5-quarter average of capital
finance ending net investment. Curiously, ANI cannot be calculated
directly from the financial statements, though we can back into the
historical ANI numbers using the margins and revenue data
provided.
Table 7: GE Capital Portfolio Margin Calculation Capital Finance
Revenues From GE 10K Segment Data Less Capital Finance Interest
From GE 10K Segment Data Contributed value Divided by ANI 5-quarter
avg of assets less non-interest bearing liabilities Portfolio
Margin
Source: Company Reports, J.P. Morgan
GE then adjusts the reported portfolio margin in a couple of
ways. First, they subtract out D&A, COGS, and maintenance
expense (a small number for GE Capital) as well as net gains and
impairments. Second, they remove the impact of what the company
calls restructuring assets, a portfolio of businesses that GE looks
to wind down over time. This was ~$50B at the end of 2009, with the
largest components being UK mortgage (~$21B), certain equipment
leasing platforms (~$15B), as well as various other consumer
assets. The company believes these assets to have limited impact on
margins in 2009 and 2010, meaning they yield near the company
average. Adjusting for these items, we get a closer representation
to the core margin for the ongoing businesses. Charts from the
December analyst day show that GE expects this core margin to
increase ~40bps in 2010 (we detail our own forecast in the next
section).
Table 8: Company Data & Guidance - Capital Finance Portfolio
Margin 2006 2007 2008 2009E 2010E
Capital Finance Portfolio Margins 9.8% 9.0% 7.5% ~6.3% ~6.5%
Less Margin Impact of "Restructuring" Assets (1.4%) (1.0%) (0.7%)
~(0.1%) ~0.0% Less D&A, COGS, Net gains/maintenance (2.7%)
(2.6%) (2.0%) (1.6%) (1.4%) Adjusted Capital Finance Portfolio
Margins 5.7% 5.4% 4.8% 4.6% 5.0%
Source: Company Reports
Finally, we relate portfolio margin to GECS earnings, which is
obviously important in terms of extracting meaning from the numbers
provided. Essentially, the reported portfolio margin gives Capital
Finance CV (revenues less interest), from which you then subtract
all the other GECS expense accounts. The final adjustments are to
include the incremental revenue and interest included in GECS but
not in the Capital Finance reporting (mostly the insurance run-off
and other corporate items). We reconcile the 2008 figures below as
an illustration. With this background, the following section walks
through our analysis and earnings estimate using margin data
provided by GE.
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Table 9: Walk: Capital Finance Portfolio Margin to GECS Net
Income $mm except margin data
2008 Notes Capital Finance Revenues 67,008 From GE 10-K, segment
data Capital Finance Interest 25,094 From GE 10-K, segment data
Portfolio Margin 7.5% From Company presentations ANI (5-point avg,
implied) 558,853 Reported CV 41,914 GECS D&A (9,330) From GECS
10-K GECS Op & Admin (18,755) From GECS 10-K GECS COGS (1,517)
From GECS 10-K GECS Investment contracts, insurance (3,421) From
GECS 10-K GECS Minority Interest (231) From GECS 10-K GECS
incremental revenues 4,279 Difference between Cap Finance and GECS
revenues GECS incremental interest expense (22) Difference between
Cap Finance and GECS interest expense GECS Pretax, Pre Provision
Profit (PTPP) 12,917 GECS Provisions for losses (7,518) GECS Pretax
Income 5,399
Source: Company Reports, J.P. Morgan
Our Crack at Measuring the Impact of Better Loan Pricing The key
dynamic behind the next several years at GE Capital will be the
roll-off of older, lower margin assets, replaced by business that
is currently being written at a much higher margin. Data from the
December investor day illustrates this, using the adjusted margin
definition described above.
Figure 22: Commercial Margins: New vs. Run Off 2009E, adjusted
portfolio margins
2.9%
4.7%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Run-Off New Volume
Source: Company reports
Figure 23: Commercial Margins: New vs. Run Off 2009E, adjusted
portfolio margins
9.1%
12.5%
0.0%2.0%4.0%6.0%
8.0%10.0%12.0%14.0%
Run-Off New Volume
Source: Company Reports
Below, we use information on collections and originations
provided in recent GE presentations to put together a picture of
how the portfolio compositions and returns may evolve over the next
several years. For example, as of midyear the company had targeted
$41B of 2009 commercial originations and $112B of consumer
originations, numbers we use to guide our estimates. We center our
analysis on the core (ex-restructuring) portfolio as we expect GE
to wind down most of the ~$50B restructuring assets between now and
2013 through a combination of collections or asset sales. We model
the company moving to ~$400mm in capital finance ENI by the end of
2012, in line with guidance. As for new volumes, we see steady
issuances in consumer but a pickup in commercial originations
(where volumes were depressed in 2009), moving back to the
historical 4-5 year turnover rate for the commercial book.
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Table 10: JPM Originations/Collections Forecast $mm except where
noted
2009 2010E 2011E 2012E 2013E GECS total assets 650,241 600,885
555,341 512,841 502,841 Discontinued assets 1,595 1,595 1,595 1,595
1,595 Non interest bearing liabilities 75,700 70,700 60,700 60,700
50,700 GECS ENI 572,946 528,590 493,046 450,546 450,546 GECS HQ ENI
79,400 67,544 59,500 44,500 44,500 Cap Fin ENI 493,546 461,046
433,546 406,046 406,046 Restructuring Assets (Global
Mortgage/Equip) 50,000 45,000 35,000 20,000 0 ENI 443,546 416,046
398,546 386,046 406,046 ANI (average) 456,874 429,796 407,296
392,296 396,046 ENI 443,546 416,046 398,546 386,046 406,046
Commercial 330,500 310,000 295,000 285,000 300,000 Consumer 113,046
106,046 103,546 101,046 106,046 Restructuring 50,000 45,000 35,000
20,000 0 Collections 175,656 205,400 201,640 200,072 171,176
Commercial 63,085 82,900 83,640 82,072 60,676 Consumer 112,571
122,500 118,000 118,000 110,500 Restructuring 5,000 5,000 10,000
15,000 20,000 Collections Growth 17% -2% -1% -14% Commercial 31% 1%
-2% -26% Consumer 9% -4% 0% -6% New Volume 149,000 177,900 184,140
187,572 191,176 Commercial 39,000 62,400 68,640 72,072 75,676
Consumer 110,000 115,500 115,500 115,500 115,500 Volume Growth 19%
4% 2% 2% Commercial 60% 10% 5% 5% Consumer 5% 0% 0% 0% Implied
turnover rate (years) 5.1 4.4 4.0 3.9 Source: J.P. Morgan
estimates
With estimates around the total originations and collections, we
then provide a detailed walk showing how the new, higher margin
assets roll onto the book. Starting with commercial, we assume that
margins on new business compress gradually over time as competition
returns but continues to come on at a higher margin than existing
loans on the book, giving ~30-40bps of margin accretion per year
over the next several years. For consumer, we divide the book into
two parts, a quick turn portion consisting of installment and
revolving credit, and a slow turn portion consisting of all other
auto loans, mortgages, and related products. The dynamics here are
near-term lift from the shorter cycle cards business, where pricing
has been more favorable and the book turns quickly, while the other
assets roll off more slowly over time. In consumer also we assume
modest degradation over the course of the cycle as competition
returns, but we see margins staying above the run-off volume in
2009.The bottom line is that we get modestly above the ~5% margin
guidance for 2010, with further improvement each of the next
several years. All in, the improvements in margin more than offset
asset declines in the core portfolio, a net positive for absolute
CV. In total, we see a tailwind for CV of ~$3 B over the next
several years, front end loaded in 2010 and 2011.
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Table 11: GECS CV Build (Ex-Restructuring Assets) $mm except
margin data
2009 2010E 2011E 2012E 2013E Consolidated ENI End 443,546
416,046 398,546 386,046 406,046 CV 21,016 21,824 22,010 22,447
23,729 Total CV Margin 4.6% 5.1% 5.4% 5.7% 6.0% Commercial ENI End
330,500 310,000 295,000 285,000 300,000 CV 10,276 10,514 11,081
11,810 13,052 Total CV Margin 3.0% 3.3% 3.7% 4.1% 4.5%
CLL Americas ENI End 105,760 116,383 117,997 121,704 134,521
CV 4,023 4,622 5,753 5,811 6,384 Total CV Margin 3.5% 4.2% 4.9%
4.8% 5.0%
Other Comm'l ENI End 224,740 193,618 177,004 163,296 165,479
CV 6,254 5,891 5,328 5,999 6,669 Total CV Margin 2.7% 2.8% 2.9%
3.5% 4.1%
Consumer - total ENI End 113,046 106,046 103,546 101,046 106,046
CV 10,740 11,311 10,929 10,637 10,677 Total CV Margin 9.4% 10.3%
10.4% 10.4% 10.3%
Consumer - slow turn ENI End 51,840 48,579 46,249 47,472
45,459
CV 3,318 3,351 3,278 3,383 3,354 Total CV Margin 6.3% 6.7% 6.9%
7.2% 7.2%
Consumer - quick turn ENI End 61,206 57,467 57,297 53,574
60,587
CV 7,422 7,959 7,651 7,254 7,322 Total CV Margin 12.0% 13.4%
13.3% 13.1% 12.8%
Source: J.P. Morgan estimates
Bottom Line: GECS Net Income of ~$4 B Likely in 2011 Finally we
take these core (adjusted) margin estimates to bridge to GECS net
income. To get back to reported CV, we add back the CV from
restructuring assets (assumed at 5% margin) and total
D&A/maintenance/net gains (guided to 1.4% for 2010, and we
assume modest improvement for 2011). Securitization gains will go
away following the FAS 167 accounting change, offset by the $1.3B
of new earnings from assets brought on book, all in line with
company guidance. The major lever beyond this is provisions, which
we believe fall modestly in 2010 with a bigger ramp down in 2011.
We apply a 10% tax rate to reach our 2010 net income number of
~$4B. It is also important to note that this is a clean earnings
number, not assuming any meaningful gains in areas like Real
Estate.
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Table 12: Portfolio Margin to GECS Earnings Walk $mm
2009 2010E 2011E Adjusted Portfolio Margin 21,016 21,824 22,010
D&A/Gains/Maintenance 8,317 6,682 7,604
D&A/Gains/Maintenance % of ANI 1.6% 1.4% 1.7% Bringing
Securitization assets on book 1,300 1,300 Restructuring ops CV
3,415 2,412 2,031 ANI (5-point avg, implied) 519,810 477,296
447,296 Reported CV 32,748 32,218 32,945 GECS D&A (8,325)
(7,547) (6,974) GECS O&A (15,175) (14,872) (14,872) GECS COGS
(799) (825) (866) GECS Investment contracts, insurance (3,193)
(3,033) (2,882) GECS Minority Interest 0 0 0 GECS incremental
revenues 3,511 3,160 2,844 GECS incremental interest expense (68)
(68) (68) GECS Pretax, Pre Provision Profit (PTPP) 8,699 9,034
10,128 GECS Provisions for losses (10,928) (9,517) (5,977) GECS
Pretax Income (2,208) (484) 4,151 Taxes 3,829 2,484 (415) GECS Net
income 1,621 2,000 3,736 Source: Company data, J.P. Morgan
estimates
GE Industrial: Steady State with Economy, Upside Potential at
Aviation Outside GECS, our forecast for Industrial remains
conservative, showing only 4% revenue and 7% profit CAGR in the
years ahead. The performance through the downturn has surprised us
if guidance/JPM estimates of flat industrial profits holds for
2010, this would be a peak to trough EPS decline of only 18% versus
the group average of 30%, close to best in class. There is not too
much new news on the Industrial businesses, though, slowly, things
look like they are turning. Indeed, thinking back to this fall,
there was really nothing in the GE Industrial portfolio that was
moving in a positive direction. Energy Infrastructure orders were
still getting worse, along with Healthcare, which had its worst
order quarter of a brutal cycle, while Transportation continued to
fall off a cliff. Lastly, Aviation aftermarket was also getting
worse, with OE production cuts looming. Slowly, some things have
changed. Oil and Gas and Healthcare had solid 4Q orders, and while
Energy trends have not changed much, GE Aviation looks to be at an
inflection with related macro data, positive new news.
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Table 13: After Challenging Mid 2009, Industrial Trends
Improving GE Business 2Q/3Q09 Trends Today Energy Major equipment
orders down 62%/50% in
2Q/3Q respectively 4Q equipment orders down 22%, almost twice 2Q
levels; margins top 20% on favorable mix/services margin
performance
Oil & Gas Major equipment orders -7% in 2Q Equipment and
services orders both up 30% in 4Q
Aviation Flight hours continue to slow, average daily order
rates for spares hits trough of $18.6mm in 3Q (down ~20% y/y)
Flight hours improving, daily spares order rate improves to
$19.6mm in 2Q, Airbus announces narrowbody production increase
Healthcare Equipment orders down 13%/15% in 2Q/3Q respectively;
service orders and revenues decline y/y
4Q equipment orders up 13% y/y and 40% sequentially; services
orders +6% y/y
Transportation 2Q equipment orders down 71% y/y 4Q equipment
orders down 40% Source: Company reports, J.P. Morgan
GE Aviation Upside Could Be Enough to Move the Needle Recent
news flow suggests that the biggest upside opportunity near term
may come in Aviation. First, on the OE side there is the well
publicized narrow body production increase at Airbus and news that
Boeing may consider similar moves midyear for the 777 and 737.
While it is too early to call whether this is the bottom in the OE
cycle, this is a clear positive relative to expectations just
months ago that a narrow body production cut was likely. The real
opportunity for upside comes on the services side, however, which
we estimate carries ~30% margins and represents 15-20% of total
Industrial profits, big enough to move the needle. A couple of data
points stand out here. First, the 10K showed a Tech Infrastructure
services backlog for next years delivery stronger than expected at
$11.9B, which compares to $9.2B estimated a year ago. We think this
is driven in part by Aviation, where GEs installed base remains in
a favorable portion of the cycle with respect to highly profitable
engine overhauls. Note that 40% of GE engines have yet to go
through their first shop visit, while 60% have yet to see their
second visit.
Figure 24: Aviation Installed Base in Sweet Spot for High Margin
Overhauls . . .
40%
60%
Engines Yet to Hav e 1st Shop Visit Engines Yet to Hav e 2nd
Shop Visit
Source: Company reports
Figure 25: . . . Which We See in Strong Expected Services
Backlog Deliveries for 2010 Technology Infrastructure service
backlog expected for forward year delivery
9.2
11.9
02468
101214
2009E 2010E
Source: Company reports
As for spares orders, driven more by utilization and flight
hours, flight hours comps are improving as airlines lap last years
declines. While aftermarket peers have not yet seen a turn in the
orders, deferral/de-stocking activity is stable, and most expect
significant improvement in 2H as airline purchasing activity
realigns with flight
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hours. For example, UTX sees 6-7% growth in spares for 2010
(including price gains), while COL expects its aftermarket
businesses to be up 6% (-5% 1H, up mid-teens 2H of September-end
FY). GE daily order rates for spares declined through the first
three quarters of 2009 ($21.6mm 1Q, $20.4mm 2Q, $18.6mm 3Q),
bouncing back to $19.6mm, still an 11% y/y decline. If the
improvement forecast by peers materializes in the 2H, this would be
an additional upside lever for services; overall, with a favorable
backlog and improving trends seen at peers, there are reasons to
believe that performance could ultimately be better than the mid-SD
increase we forecast in our model.
Valuation: If They Can Beat, Multiple Should Expand Moving to
valuation, GE looks cheap at face value at ~13x 2011E EPS versus
the group at ~16x, and even cheaper at 9.5x normalized earnings.
The pushback is that with 30% of 2011E earnings in GECS and
structural growth pressures there, the valuation deserves a
discount, with the most bearish view at 1x tangible book of $38B or
$3.50 per share. We note that currently there is a range around
financials, with the best franchises trading at 3-5x tangible book,
or ~2x book, and the weakest trading at just under 1x tangible
book, or ~0.5x book. The table below shows who these players are
and at what levels they trade.
Table 14: Financials Valuations Price/Book Price/Tangible
Book
AXP 3.37 BK 5.06 USB 2.03 AXP 4.27 SBNY 1.95 USB 3.59 VLY 1.86
PNC 2.92 TCB 1.72 MTB 2.87 SIVB 1.69 STT 2.71 CYN 1.55 VLY 2.50 STT
1.52 BBT 2.40 WFC 1.50 CYN 2.19 TRMK 1.40 TCB 1.98 MTB 1.35 WFC
1.97 FHN 1.35 SBNY 1.95 BBT 1.31 TRMK 1.95 BXS 1.28 Average 1.94 BK
1.25 SIVB 1.69 Average 1.24 BXS 1.66 PNC 1.21 FITB 1.60 CMA 1.15
UMPQ 1.56 FITB 1.08 BAC 1.52 PVTB 1.03 COF 1.51 PBCT 1.02 FHN 1.48
WTNY 0.92 PBCT 1.45 WBS 0.88 WBS 1.42 UMPQ 0.83 STI 1.41 STI 0.76
WTNY 1.37 ZION 0.76 CMA 1.19 BAC 0.75 PVTB 1.16 C 0.73 SUSQ 1.16
COF 0.68 RF 1.05 RF 0.60 ZION 1.04 MI 0.60 C 0.94 SUSQ 0.43 MI
0.68
Source: Bloomberg
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We are of the view that, in the worst of times, many financials
can be looked at as insolvent using market prices to mark down
their books, while in a more normal environment, the goodwill has
some value. As per history, the trading range for a broad peer
group has typically been north of 1x book. Our call on GE is that,
as earnings move up, and comfort around the cycle matures, the
valuation range on GECS can move back toward 1x book. Indeed,
throughout the last 20 years, using a 20% premium on the EE/MI
average for Industrial earnings, the implied multiple for GECS was
well above 1x and would move cylically with earnings (shown below
through ROA). We see a similar scenario this cycle where, once
investors get visibility on a turn in profitability, the multiple
can expand off depressed levels. Keep in mind, we are not saying
that GECS should trade at the high multiple of its past but rather
that it should move closer to book value over time and move
directionally higher off its current levels.
Figure 26: GECS Historical Implied Price/Book Implied Value,
assumes 20% premium to EE/MI peers on FY1 Industrial EPS GECS Book
Value GECS ROA
-2-101234
Jan-
90
Jan-
92
Jan-
94
Jan-
96
Jan-
98
Jan-
00
Jan-
02
Jan-
04
Jan-
06
Jan-
08
Jan-
10
Jan-
12
0.0%
0.5%
1.0%1.5%
2.0%
2.5%
Implied GECS P/B 1x P/B GECS ROA
Source: Bloomberg, J.P. Morgan estimates
Figure 27: Financials Have Historically Averaged >1x BV Group
includes C, WFC, BAC, USB, PNC, BBT, RF, STI, FITB, AXP, COF
0
1
2
3
4
Jan-
90
Jan-
92
Jan-
94
Jan-
96
Jan-
98
Jan-
00
Jan-
02
Jan-
04
Jan-
06
Jan-
08
Group Av erage 1x BV
Source: Bloomberg, J.P. Morgan
Looking at the implications for FY11 EPS in more detail, the
EE/MI group currently trades at ~15 consensus 2011 estimates. Using
our estimated $0.93 of Industrial EPS in 2011, valued at a 20%
premium to industrial peers, the current stock price appears to
imply almost no value for GE Capital. Our Dec 2010 $22 price target
implies that
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this moves to ~0.8x BV, which would still be among the lowest in
the still below average financials space and below the ~1.25x
average multiple.
Table 15: Current Valuation Implies Little Value for GE, While a
Reversion Could Drive Upside FY11 EPS Multiple Per Share
Industrial EPS 0.95 18.0 17.05 BV/share Multiple Per Share
GECS Implied 6.60 0.0 0.24 Current Stock Price 17.29
FY11 EPS Multiple Per Share Industrial EPS 0.95 18.0 17.29
BV/share Multiple Per Share GECS 6.60 0.7 4.71 Price Target
22.00
FY11 EPS Multiple Per Share Source: Bloomberg, J.P. Morgan
estimates
As a check, we also look at a simplified sum of the parts where
investors could get exposure to a high-quality industrial peer
(EMR) and a large-cap bank trading below 1x tangible book (BAC), a
trade that we hear a lot about in our travels. Using current
multiples for both, it implies this is an unfavorable way for a
price-sensitive investor to create a synthetic GE." Applying these
multiples to the constituent parts of GE suggests investors are
paying a 7% premium to re-create GE.
Table 16: Using a EMR/BAC Composite, GE Shares Still Look
Attractive FY11 EPS EMR
Multiple Per Share
Industrial EPS 0.93 16.6 15.49
Tangible BV Per Share
BAC Multiple
Per Share
GECS 3.68 0.75 2.76 Implied Stock Value 18.25 Current Stock
Price 17.29 Premium/Discount -7%
Source: Bloomberg, J.P. Morgan estimates
Valuation & Risks We remain Overweight GE shares trade at
~9.5x our normalized 2013 EPS estimate of $1.80, a ~25% discount to
EE/MI peers. While GE has traditionally traded at a premium to the
group, we think a parity multiple is more appropriate going forward
given a less levered GECS but best-in-class assets in the
infrastructure segments. Our $22 Dec 2010 price target is based on
12x normalized (2013) earnings, or a 16x mid-cycle multiple
discounted back at a 10% rate, which is in line with our target for
the group.
Risk to our rating Downside risks at GECS include (1) the
failure to realize tax synergies with the industrial parent; (2)
tail risk around regulatory action that forces a sale of distressed
Real Estate assets; (3) higher than expected losses or impairments
from real estate; and (4) further pressure on the global financial
system that hurts asset values or limits GECS access to the
wholesale funding markets. Downside risks at Industrial include
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C. Stephen Tusa, Jr CFA (1-212) 622-6623
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(1) Prolonged weakness in global power markets that hurts energy
orders; (2) weaker than expected commercial air traffic that hurts
Aviation services; (3) US healthcare legislation causes another leg
down in hospital capital equipment spending; or (4) continued
weakness in film and advertising markets
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Analyst Certification: The research analyst(s) denoted by an AC
on the cover of this report certifies (or, where multiple research
analysts are primarily responsible for this report, the research
analyst denoted by an AC on the cover or within the document
individually certifies, with respect to each security or issuer
that the research analyst covers in this research) that: (1) all of
the views expressed in this report accurately reflect his or her
personal views about any and all of the subject securities or
issuers; and (2) no part of any of the research analysts
compensation was, is, or will be directly or indirectly related to
the specific recommendations or views expressed by the research
analyst(s) in this report.
Important Disclosures
Lead or Co-manager: JPMSI or its affiliates acted as lead or
co-manager in a public offering of equity and/or debt securities
for General Electric Co. within the past 12 months.
Client of the Firm: General Electric Co. is or was in the past
12 months a client of JPMSI; during the past 12 months, JPMSI
provided to the company investment banking services, non-investment
banking securities-related services and non-securities-related
services.
Investment Banking (past 12 months): JPMSI or its affiliates
received in the past 12 months compensation for investment banking
services from General Electric Co..
Investment Banking (next 3 months): JPMSI or its affiliates
expect to receive, or intend to seek, compensation for investment
banking services in the next three months from General Electric
Co..
Non-Investment Banking Compensation: JPMSI has received
compensation in the past 12 months for products or services other
than investment banking from General Electric Co.. An affiliate of
JPMSI has received compensation in the past 12 months for products
or services other than investment banking from General Electric
Co..
JPMorgan and or its affiliates is acting as financial advisor to
General Electric Corp. (NYSE: GE) in connection with the signed
definitive agreement to form a joint venture that will be 51
percent owned by Comcast (NASDAQ: CMCSA, CMCSK), 49 percent owned
by GE and managed by Comcast. The announcement was made on December
3, 2009. The transaction has been approved by the Board of
Directors of GE and Comcast. It is subject to receipt of various
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agencies. The transaction is also subject to other customary
closing conditions. NBCU has obtained $9.85 billion of committed
financing through a consortium of banks led by J.P. Morgan, Goldman
Sachs, Morgan Stanley, BofA Merrill Lynch and Citi.
0
15
30
45
60
75
Price($)
Oct06
Jan07
Apr07
Jul07
Oct07
Jan08
Apr08
Jul08
Oct08
Jan09
Apr09
Jul09
Oct09
Jan10
General Electric Co. (GE) Price Chart
N $8 OW $17
N $9 OW $14OW $22
N N $13 N $12 OW $17OW $20
Source: Bloomberg and J.P. Morgan; price data adjusted for stock
splits and dividends.This chart shows J.P. Morgan's continuing
coverage of this stock; the current analyst may or may not have
covered itover the entire period.J.P. Morgan ratings: OW =
Overweight, N = Neutral, UW = Underweight.
Date Rating Share Price ($)
Price Target ($)
16-Jun-08 N 29.15 -- 09-Dec-08 N 18.88 13.00 06-Feb-09 N 10.85
9.00 10-Mar-09 N 7.41 8.00 12-May-09 N 14.19 12.00 08-Sep-09 OW
13.87 17.00 19-Oct-09 OW 16.08 14.00 19-Oct-09 OW 16.08 17.00
16-Dec-09 OW 15.75 20.00 07-Jan-10 OW 15.45 22.00
Explanation of Equity Research Ratings and Analyst(s) Coverage
Universe: J.P. Morgan uses the following rating system: Overweight
[Over the next six to twelve months, we expect this stock will
outperform the average total return of the stocks in the analysts
(or the analysts teams) coverage universe.] Neutral [Over the next
six to twelve months, we expect this stock will perform in line
with the average total return of the stocks in the analysts (or the
analysts teams) coverage universe.] Underweight [Over the next six
to twelve months, we expect this stock will underperform the
average total return of the stocks in the analysts (or the analysts
teams) coverage universe.] J.P. Morgan Cazenoves UK Small/Mid-Cap
dedicated research
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analysts use the same rating categories; however, each stocks
expected total return is compared to the expected total return of
the FTSE All Share Index, not to those analysts coverage universe.
A list of these analysts is available on request. The analyst or
analysts teams coverage universe is the sector and/or country shown
on the cover of each publication. See below for the specific stocks
in the certifying analyst(s) coverage universe.
Coverage Universe: C. Stephen Tusa, Jr CFA: 3M (MMM), Danaher
(DHR), Dover (DOV), Emerson Electric Co. (EMR), General Electric
Co. (GE), Honeywell (HON), Hubbell Inc. (HUBB), ITT Corp. (ITT),
Ingersoll Rand (IR), Lennox International (LII), Rockwell
Automation (ROK), Roper Industries (ROP), SPX Corp. (SPW), Textron
(TXT), Tyco International (TYC), WABCO (WBC), Watsco (WSO), Watts
Water Technologies (WTS), Wesco (WCC)
J.P. Morgan Equity Research Ratings Distribution, as of December
31, 2009
Overweight (buy)
Neutral (hold)
Underweight (sell)
JPM Global Equity Research Coverage 42% 44% 14% IB clients* 58%
57% 42% JPMSI Equity Research Coverage 41% 49% 10% IB clients* 78%
73% 57%
*Percentage of investment banking clients in each rating
category. For purposes only of NASD/NYSE ratings distribution
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Neutral rating falls into a hold rating category; and our
Underweight rating falls into a sell rating category.
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