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5 Companies Vital To America’s Future

By Stephen Leeb on May 31, 2018

Topping our list of companies critical to America’s future (preceding article) is General Electric (NYSE: GE), which we added to Income/Value Portfolio as an Alert in May. We are betting this fallen industrial icon will recover its past glory and lead U.S. efforts to develop renewable energies.

The 2008 financial crash decimated GE’s financial division, then half of the company. Today that segment, now called GE Capital, is just 7% of the whole and has taken the last of the major write-offs associated with the financial meltdown.

That leaves GE, for the first time in a decade, positioned to focus on the industrial markets it formerly had dominated, starting with energy. Its energy-related divisions include power, renewable energy, and oil and gas. Together they generate 62% of GE’s revenues and make GE critical to America’s energy future.

The power division, which includes all assets dedicated to generating electricity, is the company’s largest industrial segment and has been the weakest. That weakness mainly reflects overcapacity in the commodity end of the power-producing business, which includes massive steam turbines and gas engines. We expect GE will aggressively reduce costs in these commodity-driven areas. Rising margins and continued strong growth in the Middle East and Africa will drive profit growth.

More than 25% of power division revenues come from grid solutions, whose products – such as advanced cabling, smart meters, circuit breakers, and software interfaces – are geared toward the smart grid. Growth is expected to be nearly 20% a year over the next three to five years, accompanied by efficiency gains. The company’s smart grid-related revenues are currently about $15 billion, the largest outside of China’s state-controlled grid company.

Through its renewable energies segment GE is a leading global provider of products related to wind energy and hydropower. Renewable energy is one of GE’s fastest-growing areas, with strong revenue growth and rising margins. Margins in the oil and gas services area have been hurt by the company’s majority investment in Baker-Hughes, a leading oil and gas service company. Going forward, we see tremendous leverage in this segment as higher oil prices lead to sharp gains in both revenues and margins. As the world’s third-largest oil and gas service provider, GE will be a go-to company in this critical arena.


GE’s major non-energy divisions are aviation and health care. It is a leading provider of both commercial and military aircraft engines and of diagnostic imaging equipment. Both divisions should see rising revenues, higher margins, and increased market share, contributing to companywide growth.

Adding it up, GE should grow faster than Street expectations of growth in the mid single digits. Given the leverage in its energy operations, we expect growth to top 10% and possibly approach the low or even mid teens. With its more than 3% dividend, GE is a strong addition to Income/Value Portfolio.

First Solar Inc. (NASDAQ: FSLR) is the West’s largest dedicated solar energy company and arguably the best positioned. It is a vertically integrated provider of solar power through its proprietary thin film technology. After its 2006 public debut, its stock price soared more than twenty-fold in 18 months. With revenues and profits climbing sharply, the stock held on to much of the gains despite the market crash.

Then the Chinese took control of the solar market with their versions of silicon/crystalline-based cells. The willingness of Chinese companies to produce at a loss undermined potential competitors, including First Solar, whose major selling point was the lower cost of thin film. Relatively flat revenues and plunging margins led to stock market disaster. Still profits this decade have remained relatively steady. And the balance sheet has remained strong, allowing First Solar to finance continued improvements in its products. Today the latest version of its technology has sold out to the early part of next decade. In both efficiency and cost, thin film is a viable competitor to crystalline cells.

Given solar’s enormous global potential, First Solar could lead in a massive and critical industry, with growth limited only by its ability to keep adding capacity. That assumes management can continue to execute and that some disruptive new technology doesn’t emerge. While relatively small and potentially volatile, First Solar has the potential to keep America in the renewable race and belongs in any renewable energy or commodity portfolio.

Growth Portfolio is overweighted in defense, and while we wish the world didn’t make it necessary, a strong defense remains essential. Current P/Es for major defense companies are the highest in modern times, even higher than after 9/11. Yet the stocks aren’t overvalued. The U.S. still has a defense advantage over China, but it will last only if the U.S. continues upgrading and broadening its military prowess. The massive defense budget is in line with the challenge.

Our three recommendations, CACI (NYSE: CACI), Northrop Grumman (NYSE: NOC), and Raytheon (NYSE: RTN), cover the waterfront. While current P/Es are high, they are matched by burgeoning defense spending. For both Northrop and Raytheon, that should push earnings growth to the mid teens through at least early next decade. Thus PEGs for both companies are moderate, while projected free cash flow for both is high.

While both have similar growth trajectories and valuations, their path to these metrics is different. Northrop leads in strategic programs – the F-35 and its likely successor and/or complement, the B-21. The company also will have a big role in upgrading the U.S. missile-based nuclear deterrent. The proposed acquisition of Orbital ATK, if approved, will enhance the company’s space offerings and be almost immediately synergistic, likely boosting five-year growth to 15% or a touch higher. Northrop will likely be the fastest-growing major defense company.

But Raytheon won’t be far behind. Its vaunted Patriot missile is set to expand worldwide with orders from Europe, the Middle East, and Asia. One area of competition between Northrop and Raytheon is space, where Raytheon has a slight edge even if the Orbital purchase goes through. Raytheon also gets high marks in electronics, a reason its cyber program is very strong. Finally, Raytheon is the most geographically diverse defense contractor, with nearly a third of revenue coming from abroad. Both companies have exceptional balance sheets, though Raytheon has higher margins and slightly better financials. We advise owning them both.

CACI is one of the least transparent companies around – ironically, one reason we like it. We do know it’s a main provider of cyber services to the Defense Department. We also know (from its human resource ads) that some top engineers must speak Mandarin at a technical level. High free cash flow has let CACI grow both organically and through acquisitions. The long-term pattern has been relatively steady earnings growth during times of defense cutbacks and explosive growth when defense spending rises. Cybersecurity is critical for the DOD, and CACI is a standout in this arena. We expect the stock’s stellar performance to continue.

SALE

In the Alert in which we bought GE we sold General Mills (NYSE: GIS) from Income/Value portfolio, both to make room for GE and because we felt GIS had vastly overpaid for a high-end pet food company, a sign of weakness and lack of faith in its own product line.

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  1. avatar
    Edward Getchell Reply June 4, 2018 at 1:35 PM EDT

    Stephen, today’s drop in the price of First Solar ….. about -7% …. seems to be caused by the Chinese government:

    https://seekingalpha.com/news/3361388-solar-stocks-slammed-china-imposes-new-restrictions

    Seems like an over reaction but should I continue to hold the FSLR stock and fight the Chinese government or should I move on to better opportunities?

    Ed

    • Stephen Leeb
      Stephen Leeb Reply June 4, 2018 at 4:37 PM EDT

      Hi Ed, I would hold FSLR. The Chinese moves are aimed at the polycrystalline market and not thin film. FSLR is down because of the threat of greater competition. But I think the markets are distinct enough that FSLR – especially in light of its series 6, which should sharply reduce unit costs. Keep in mind too that FSLR’s backlog extents into the early part of the next decade. Also true are that there are tariffs on the Chinese modules and FSLR derives over 75 percent of sales from the U.S.

      Solar is an enormous potential market. The only clear leader in any significant part of this market is FSLR – where thin film has a natural advantage in wide area, utility applications. FSLR also has the equivalent of 40 percent of its capitalization in cash, which should allow continued upgrades beyond series 6.

      The biggest caveat beyond shorter-term volatility is the company’s ability to continue execute. I am betting they will. Thin film is the only area of renewable energies where, thanks to FSLR, the U.S. has a clear lead. While not a reason to buy the stock, the fact that we subsidize oil companies is certainly a precedent for subsidizing a critical loner like FSLR.

      In sum, FSLR is a relatively small company which has as need to continue to innovate. It is speculative but given the enormity of the market and its leadership in an important niche, the potential rewards dramatically outweigh the risks. Still if wide swings are going to keep you up at night, then you are probably better with other commodity plays. Downside risk right now is about 58 and then worst case 50. By 2020 upside potential is low three digits. I hope this gives you some perspective. Best, Steve

      • avatar
        Martin Vetter Reply June 14, 2018 at 9:44 AM EDT

        I had a similar question, so thanks for that perspective, Steve.