On Tuesday, we took General Electric (GE) out of the bullpen and into our portfolio following Fed Chairwoman Janet Yellen's dovish speech, which provided us with a compelling macro backdrop to own a best- in-class global industrial conglomerate like GE.
A weaker dollar (USD) helps to alleviate foreign exchange headwinds, while the "lower for longer" interest rate environment makes GE's nearly 3% dividend yield relatively more attractive.
The macro backdrop is just one portion of our investment thesis. Specific to the company, we expect GE to deliver best-in-class top-line core industrial growth (1-2% faster than peers), expand core margins (by around 80 basis points vs. flat-to-contracting margins for its peers), a powerful buyback program, potential for accretive M&A and a pathway to $2.00 EPS in 2017.
We believe the GE story has fundamentally changed for three core reasons: improved management, streamlined operations/restructuring initiatives, and potential for market share gains.
First, we have more confidence in management than ever before, and think the company has assembled its best leadership team across each vertical, all of whom are executing at a high level.
At the CEO level, Jeff Immelt has emerged as a reinvigorated leader following over a decade riddled by skepticism and criticism. Regardless of the setup and timing (Immelt took the reins from legendary CEO Jack Welch on Sept. 7, 2001), shareholders struggled for the first 10 years with Immelt at the helm as he failed to create value amid a bull market.
In the same way that Welch needed Six Sigma to reinvigorate factories in the mid-1990s, Immelt has breathed new life through the "Smart Factory" concept. In the same way Welch grabbed reigns on late-'90s digitization, Immelt is helping shape the future through the "Industrial Internet" initiative: a combination of Big Data analytics with the Internet of Things, in which the company is leveraging insight into data created by industrial equipment such as wind turbines, jet engines and MRI machines.
Immelt has now assembled a team of leaders that expand across the entire C-Suite and each product vertical. CFO Jeff Bornstein is methodical, disciplined, intelligent and straight-forward. GE has a slate of impressive division heads across its four most important businesses -- David Joyce (aviation), John Flannery (healthcare), Lorenzon Simonelli (oil & gas) and Steve Bolze (power) -- along with strong leaders across geographies, including heads of its Asia and African operations.
Outside of management, the company is simplifying and streamlining its business units, which should create long-term value. GE Capital assets are being sold into a highly liquid, low-rate environment that favors sellers over buyers, particularly as buyers continue to have to stretch for yield and risk spreads remain low (as evidenced by Yellen's comments yesterday). Its remaining portfolio is diversified: power & renewables (28% of profits), aero (27%), healthcare (15%), oil/gas (less than 10%), transport (7%) and other industrial (6% of profits).
Finally, GE is gaining share and appears to be doing such at a sustainable pace. Within its diversified portfolio, GE has developed a $6 billion software revenue stream that is growing at a 20% revenue run rate, at very high margins.
Bottom line: we think GE has the right people, right initiatives and even the right shareholder base (notably Nelson Peltz's Trian Fund Management, which has GE as its top holding) to drive change within the company. It will drive change through delivering outsized core sales and profit growth, mitigating losses in risky areas such as oil/gas, creating value through new product platforms/restructuring initiatives/accretive deal- making, while benefiting from secular tailwinds outside of the company (weaker dollar, lower-for-longer interest rate environment, etc.).
Our $35 reflects just over 17x consensus 2017 EPS of $2.00.