Part of Barron's Trader column from 3-4-02; GE's Power business is discussed below:
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online.wsj.com
....The market is saying the Rust Belt is the place to be," says Steve Galbraith, chief domestic equity strategist at Morgan Stanley. Looking at economically sensitive issues in the Dow, United Technologies is up 15% to 74.20 in 2002; Honeywell has risen 17% to 39.79; GM is up 13% to 55; DuPont has advanced 12% to 48 and International Paper has gained 9% to 44.16.
The list of stocks hitting new 52-week highs on the New York Stock Exchange is peppered with industrial stocks, including many second-tier companies that now are favored by investors because they offer a leveraged recovery play. Many industrial issues are up 50% from their post-September 11 lows and have doubled off rock-bottom levels reached in early 2000, when well-known stocks commanded less than 10 times earnings.
Galbraith argues that most industrial issues "aren't cheap anymore" and some prominent value investors like Bill Nygren, head of the Oakmark and Oakmark Select funds, are emphasizing depressed growth stocks over economically sensitive issues.
But the momentum now favors industrial stocks because the economic expansion is gaining steam and investors know that it historically has paid to buy the group early in the cycle. Aggressive investors who play momentum strategies like cyclical issues because they figure that a strengthening economy will produce an extended period of upward profit estimate revisions.
One investor also cites the so-called Tyco factor. Many institutions that dumped Tyco International in recent months as it fell from the high 50s to under 30 may have reinvested those funds in other economically sensitive stocks. Because most industrial companies don't have big market values, the recycled money from Tyco, whose market value topped $100 billion in late 2001, can have a big impact elsewhere in the group.
Let's look at some of the valuations in the sector. Honeywell, United Technologies and Textron trade for 15-16 times estimated 2002 profits. Emerson Electric, at 59, trades for 20 times projected 2002 earnings; Danaher, at 68, commands 25 times estimated 2002 profits and llinois Tool Works, at 74.25, trades for 24 times projected 2002 earnings. Not cheap.
It's ironic that the ultimate industrial stock, General Electric, has been a laggard and that its valuation premium versus its multi-industry peers has contracted sharply. GE rose 1.36 last week to 39.45, but is well below its 52-week high of 53 and peak of 59 in 2000. It trades for 24 times estimated 2002 profits of $1.65 a share.
Notwithstanding Fed Chairman Greenspan's cautious forecast, the stock market was positively exuberant, sending Old Economy cyclicals in the DJIA soaring.
GE is being held back largely because of concerns that its giant power-systems division, which accounted for more than 100% of the earnings growth in its industrial businesses last year, will experience a sharp downturn in 2003, 2004 and 2005 amid a fall in deliveries of big turbines to the increasingly troubled U.S. electric industry. The power systems division generated more than $3 billion in net income for GE last year, over 20% of its total profits, and second only in importance to GE Capital.
The collapsing share prices of such independent power producers as Calpine and AES, not to mention the bankruptcy of Enron, illustrates the woes of part of GE's customer base. GE's power systems division rode the independent power industry's boom in 2000 and 2001 and is set to suffer from the coming bust although GE says it can mitigate the falloff in turbine profits with increased service revenues. GE sees the power unit's after-tax profits peaking at around $4 billion this year and then falling by around $500 million in 2003.
But J.P. Morgan analyst Don MacDougall recently estimated that the 2003 drop could be $600-$800 million. "The bigger implication for GE is that we could see at least two lean years beyond 2003" for the power division, he wrote. MacDougall and other GE watchers believe that the company can generate 10% annual profit growth in both 2003 and 2004 even with the power downturn. "GE is clearly not a leveraged recovery play, but should be viewed as a sustainable growth story," he told clients.
The problem now is that investors don't want sustainable industrial growth stories like GE, especially given concerns about whether poorly understood GE Capital can continue to generate its customary 15%-17% profit gains from a very high profit base. Another issue is that GE's power problem isn't going away anytime soon. Wall Street fears that the news flow on GEs turbine orders and deliveries will only get worse this year. |
