GE reports Friday, 4/13/07

Friday the 13th has never been associated with good luck in any form or fashion, and yet GE is prepared to report q1 '07 earnings before the bell. Current Thomson Financial / First Call consensus is looking for $0.44 in earnings per share and $39.795 bl in revenues for year-over-year growth of 13% and 5.2% respectively.

Although typically followed byWall Street industrial analysts, a big part of GE's operating income comes from GE Capital or the financial services arm, thus you really have a two-part company: GE Capital and GE Industrial, the industrial arm which accounts for about 2/3rd's of cash flow and generates about $1 in free-cash-flow for every $2 in cash generated from operations.

With a AAA-rating (credit rating), a 3% annual dividend (and plenty of room to grow) a strong stable of global businesses spread across multi-sectors and probably the best management team in industrial and financial America, you really have to wonder why the stock has been an absolute dead-fish the last two years since it closed around $36 in December, 2004.

Here is my issue with continuing to hold the stock in client portfolios: a note out of Goldman Sachs shortly after the February 26th meltdown in Shanghai and US markets noted that GE fell 8% during the market drop lasting from late February into mid-March: if the stock goes nowhere in 2006 with the S&P 500 up 15% in that year, then goes down 8% in a market swoon, that is very poor risk-reward from a performance standpoint. (In 2006, GE returned about 6% before the dividend, versus the S&P 500's 15%. For whatever reason quality growth stocks are seeing no P/E expansion, even in good markets.)

From a valuation standpoint, there is little not to like about GE: at $36 per share, and with the current '07 estimate of $2.22 per share, GE is trading at 16(x) forward earnings, for what should be an easy 10% grower through any kind of economy. In addition, the substantial cash-flow you'd expect with a AAA-rated company, leaves GE trading at about 12(x) enterprise value to 4q trailing cash from operations, which is hardly expensive today. GE's WMC Mortgage business could be an issue this quarter since GE is liable on subprime defaults within 90 days of securitization (according to a CIBC World Markets research report) , and WMC generated almost $100 ml to GE's bottom line in '06, but again, with GE's various businesses you expect these hiccups to occur (i.e. the downside of diversification) and be offset with strength in other businesses.

Bottom line: as much as I like the company, the cash-flow and the management, the stock has been a drag on performance. I feel for Jeff Immelt: Jack Welch got the benefit of a 20 year bull market and P/E expansion, whereas Jeff Immelt has seen nothing but P/E contraction and a market very unsympathetic to large-cap growth stocks in general.

There is an old saying: "amateurs hope while professionals work" so we have to see some possible catalyst for GE in Friday's report or we have to think hard about continuing to hold a perennial underperformer.

Position in GE, GS