GE Can't Compete With Toaster Maker

Story updated with GE's first-quarter financial results.

BOSTON ( TheStreet) -- The industrial conglomerate, embodied by General Electric ( GE), achieved prominence in the 1960s as managers and business academics preached the power of "synergy."

When seemingly unrelated businesses are bundled together under the umbrella of a parent company, cost-saving and cross-promotional opportunities arise. That outcome is logical, in theory, but, in practice, most conglomerates are diversified, but unfocused, and difficult to oversee. To purist investors, the conglomerate is anathema, whereas the ideal investment is a specialized company with a moat (some sustainable advantage), such as technical expertise, that keeps competitors at bay.

This sentiment is aptly demonstrated by Warren Buffett's recent purchase of Lubrizol ( LZ), a firm that makes engine lubricants and additives for oil, gasoline and diesel. Digging into this niche business reveals superlative investment merits. For example, Lubrizol sports a lofty pre-tax profit margin of 18% and a trailing 12-month return on equity of 34%. And, before Buffett offered a 24% premium for outstanding shares, Lubrizol was undervalued. On the opposite end of the spectrum is perennial dog General Electric, which reported first-quarter results today, and whose stock has plummeted 51% from a 2007 high and 61% from a 2001 apex.

Today, GE reported that first-quarter operating earnings climbed 58% to $3.6 billion, or 33 cents a share. It also raised its quarterly dividend by 1 cent a share to 15 cents.

GE has been outshined by many small-cap industrials, whose stocks continue to record new all-time highs. Three small-cap industrial equities that have surged over a three-year span are: TriMas ( TRS), a specialized machinery company, with packaging, energy and aerospace operations; MasTec ( MTZ), which produces, installs and maintains high-tech communications infrastructure; and National Presto ( NPK), a pint-sized conglomerate that makes products ranging from munitions to toasters. Presto is perhaps the best in the bunch, and the David to GE's goliath. Though it owns diverse businesses, Presto is focused.

With a $738 million market value, Presto is flying under the radar, manufacturing small appliances, such as toasters and pressure cookers, defense products, including ammunition, and absorbent products, including diapers. This variety of unrelated products has yielded consistency for Presto, whereas for GE, whose business units range from a multi-billion dollar financing arm to a turbine-manufacturing unit, diversification hasn't yielded promised synergy. Presto has propelled revenue and net income 4.4% and 18%, annually, on average, since 2008. In contrast, GE's sales and profit dropped by 4% a year and 19% a year, respectively.

No sell-side analysts cover Presto's stock, which has delivered annualized gains of 29% since 2008, but has fallen 2.3% in the past 12 months and is down 14% this year. It's now fallen to attractive levels, based on peer valuation and dividend potential. It trades at a trailing earnings multiple of 11, a forward earnings multiple of 10 and a book value multiple of 2.1, indicating respective discounts of 41%, 32% and 62% to industry averages. Presto has been ranked "buy" by the quantitative equity model used by TheStreet Ratings since April 2009. It has returned 51% since then, excluding distributions, which are lofty and continue to grow.

The company's enterprise-value-to-EBITDA ratio, an ideal way to compare it to companies that finance differently, at 5.8, reflects a huge 47% discount to its peer group average. Presto's free-cash-flow yield, considered by some to be the best valuation metric for stocks, was a healthy 4.5% for 2010, when it generated $58 million of cash from operations and poured $18 million into capital expenditures, for $40 million of free cash flow, an impressive amount.

Presto has an ideal financial position, with $151 million of cash and no debt. Its quarterly return on equity, at 18%, missed the industry average of 36%, largely because it is less levered than peers. Return on assets, however, which provides greater clarity on overall profitability, was outstanding -- above 15%.

Presto pays its dividend at the end of each calendar year, declaring a regular payment and a special dividend on top. Since most screeners don't account for special dividends, it appears that Presto offers a paltry yield of just 0.9%, which only accounts for the annual $1 payment from the company. In reality, the yield is upwards of 7%. The distribution has grown 25% and 31%, annually, over a three- and five-year span, respectively. The payout has steadily climbed from $2.45 in 2008 to $7.25 in 2011. The last dividend translated to a yield of 6.3% upon declaration date.

Not only is Presto a fast-growing and stable company, but it is among the best-managed small-cap industrials and is absolutely committed to generating shareholder returns.

-- Written by Jake Lynch in Boston.

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