Industrials

Valuing The Best Conglomerate For The Second Half of 2011 (GE, UTX, BRK-A, HON, MMM, TXT, TYC)

24/7 Wall St. has been using valuation analysis for value investors for a couple of weeks and we wanted to review the conglomerates in a search for the best value for long-term investors as of this summer.  The current woes in Europe and the debt ceiling debate in the U.S. are two key issues to consider, but the goal is try to get past the news and noise of today and this summer.

We evaluated General Electric Co. (NYSE: GE); United Technologies Corp. (NYSE: UTX); Berkshire Hathaway Inc. (NYSE: BRK-A); Honeywell International Inc. (NYSE: HON); and 3M Co. (NYSE: MMM).  Also included were reviews of Textron Inc. (NYSE: TXT) and Tyco International Ltd. (NYSE: TYC).

In our analysis, we considered prices, forward P/E ratios, dividend yields, and return on equity.  We also then considered the fundamentals of each and included an implied upside to the Thomson Reuters consensus price targets.  Conglomerates are in a different position that they were in 2010 and now the field is mixed.  Some stand out above and beyond peers, and some look tired in the current market.

General Electric Co. (NYSE: GE) pays a 3.2% dividend.  The company sells at a price to book ratio of about 1.6 to 1.  Its forward price earnings multiple is 11.4 and its return on equity is 11.25%.  GE’s shares recently traded at $18.63.  The 52-week price range is $13.83 to $21.33. Thomson Reuters has a consensus price target of $23.87, implying roughly 28% upside.  General Electric is also in the midst of solar investing as well as other new financings, but that is the norm for a company the size of GE.  This price-to-book value seems rather low, and we would be the first ones to admit that trying to accurately place a book value on G.E. at any given time would not be an easy feat.  With much still tied to consumer and customer financings, investors have to also understand that G.E. remains more of a bank compared to other conglomerates. It also has the highest market capitalization of all conglomerates again at $197 billion.

United Technologies Corp. (NYSE: UTX) pays a 2.13% dividend.  The company sells at a price to book ratio of 3.7 to 1.  Its forward price earnings multiple is 14.6 and its return on equity is 21.5%.  United Technologies recently traded at $90.35.  The 52-week price range is $63.53 to $91.83. Thomson Reuters has an average price target of $97.83, implying that it has almost 10% upside.  United Tech is one that we recently noted could become one of the next mega-caps with a $100 billion market capitalization, which is really not too much higher than the consensus price target objective when you consider a $82 billion market cap.  That will not happen if the economic worries morph into something worse.

Berkshire Hathaway Inc. (NYSE: BRK-A) sells at a price to book ratio of about 1.2 to 1, but it pays no dividend to its shareholders.  Its forward price earnings multiple is 15.2 and its return on equity is 7.06%.  This Warren Buffet progeny has not yet announced a dividend, though many industry observers believe it’s about time they did.  Berkshire Hathaway recently traded at $113,000.00.  The 52-week price range is $109,925.00 to $131,463.00. Without an official price target, the upside depends upon your interpretation of what sort of premium this one should trade at against book value.  The biggest trick about Berkshire Hathaway is to remember that net income on any given quarter is not the metric to use because Warren Buffett has said it could be almost whatever they wanted due to mark-to-market and due to quarterly fluctuations in all of its units.  That is fortunate considering that the company’s insurance losses cut its earnings in half at the last earnings report.  There are two words that the media has not used in a month or more and the company has to be happy about it: David Sokol.  This pending acquisition of Lubrizol has not yet closed, although it is not a huge transaction despite the $8.6 billion market cap.

Honeywell International Inc. (NYSE: HON) pays a 2.23% dividend.  The company sells at a price to book ratio of 4 to 1.  Its forward price earnings multiple is 13 and its return on equity is 21.65%.  Honeywell shares recently traded at $59.54.  The 52-week price range is $37.41 to $61.93. Analysts have a consensus price target of $68.50, implying upside of roughly 17%. While this is no game-changing event, Honeywell is in the midst of acquiring EMS Tech for its rugged mobile computing and satellite communications.  With a market cap of almost $46 billion, it is unlikely on the surface that a repeat buyout offer like what G.E. offered about ten years ago will ever come back up.  We have always evaluated Honeywell as a standalone conglomerate rather than as a buyout candidate (even at the peak of the private equity craze).

3 M Co. (NYSE: MMM) pays a 2.25% dividend and its market cap is $68 billion.  The company sells at a price to book ratio of 4.2 to 1.  Its forward price earnings multiple is 13.8 and its return on equity is 28.2%.  The shares of 3M Co. recently traded at $97.62.  The 52-week price range is $76.99 to $98.19.  The consensus price target from Thomson Reuters is $107.76, implying nearly 12% upside.  3M feels rather fully valued compared to the peers in the marketplace, and the belief in a further changing of management could create some implied unknown situations.

Textron Inc. (NYSE: TXT) pays a tiny 0.3% dividend.  The company sells at a price to book ratio of 2.1 to 1.  Its forward price earnings multiple is 12.9 and its return on equity is 4.3%.  Textron’s shares recently traded at $22.20 and its 52-week price range is $16.60 to $28.82.  Thomson Reuters has a consensus price target of $30.21, implying an upside of about 36%.  Textron is a mini-conglomerate with a $6.1 billion market capitalization, but it is generally too small to be considered a conglomerate.  We have also noted how it fails the conglomerate dividend test.  The only reason it is even being included is because of its high upside to the consensus price target.  That may just be because its shares have sold off more than peers. While the implied upside at Textron is appealing, it was only included in the analysis because of that implied upside.

Tyco International Ltd. (NYSE: TYC) is included even though its conglomerate days are less and less true now.  The company pays a 2.0% dividend.  The company sells at a price to book ratio of 1.7 to 1.  Its forward price earnings multiple is 13.5 and its return on equity is 9.9%.  Tyco’s shares recently traded at $48.93 and the 52-week price range is $34.20 to $53.10. With a consensus price target of $55.25, this implies upside of roughly 13%.  We would note that Tyco is a former conglomerate that has effectively now deconglomerized.  There was also a takeover premium in the company as there were reports of it being subject of a buyout.  This did not occur and we estimated $60 was the peak-purchase valuation based on our EBITDA, earnings, and break-up valuations at the time.

The current 24/7 Wall St. top conglomerate is again General Electric Co. (NYSE: GE).  The notion that this was one of our Top Ten Stocks To Own for the Next Decade actually played very little into our analysis this summer.  Even though we do not exactly rely heavily on that low price-to-book multiple, its dividend north of 3%, upside of 28%, and its low implied forward P/E ratio are worth noting.  G.E. is also down about 10% from its recent highs and is still half of its size back at the pre-recession peak.  It is also down marginally as far as its stock performance in 2011.  We actually do expect that the nuclear business slowdown after Japan and after other countries applied the brakes will have an impact on business and that is part of the reason that its earnings multiple and implied book value are lower than most.  The valuations in the rest of the business make up for at least most of this segment’s turmoil.

In mid-May at an EPG conference, Chairman & CEO Jeff Immelt again praised the portfolio mix by noting that the company is very happy with the portfolio infrastructure in financial services and called the portfolio the most competitive it has been in at least ten years. The concern that G.E. would go do a huge deal also seems off the table now as Immelt noted, “We just don’t see a lot of macro changes in the portfolio in the short-term.”  Another catalyst we see helping is that GE is now repurchasing shares and it is soon to turn in those 10% preferred shares back to Warren Buffett after the recessionary pressure forced it to borrow.

Unfortunately, current market conditions do merit at least one caveat even for value-investors who are not trying to predict an absolute bottom or an absolute top on any given day or week.  The troubles in Europe are becoming far worse than just what a Japan-led slowdown at the same time as China and India are putting on the economic squeeze to keep inflation lower. All that being said, G.E. still appears to offer the best defensive posturing and the most upside of its conglomerate peers.

Earnings season is underway, so stay tuned.

JON C. OGG

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