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General Electric Company's (NYSE:GE) oil and gas business has suffered a significant decline in the last two years as a result of the crashing crude oil prices. However, General Electric has demonstrated a strong belief in the growth prospects of its oil and gas business by combining with one of the world's leading oilfield services companies Baker Hughes (NYSE:BHI). The merger represents a considerable cost for GE but it has more to offer than that. It is indeed a smart move, and it will drive the GE stock in the coming years. Here's Why.

GE's oil and gas segment revenues have dropped 42.6% from $5,162 million in the fourth quarter of 2014 to $2,964 million in the third quarter of 2016. Moreover, the segment profits have fallen 60% over the same period from $881 million in Q4 2014 to $353 million in Q3 2016.

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Source: Company reports

On October 31, General Electric announced that it has entered into an agreement to combine its oil and gas business with Baker Hughes.

In the announcement GE explained:

"The New Baker Hughes will be a leading equipment, technology and services provider in the oil and gas industry with $32 billion of combined revenue and operations in more than 120 countries. By drawing from GE technology expertise and Baker Hughes capabilities in oilfield services, the new company will provide best-in-class physical and digital technology solutions for customer productivity."

The merger represents a considerable cost for GE as, under the agreement, it will contribute $7.4 billion to fund the $17.50 per share special dividend to existing Baker Hughes shareholders to own 62.5% of the new company. As such, investors might worry that GE is paying too much for the deal. However, in my view, combining with Baker Hughes to create the new mega oilfield services company is a smart move by GE. After all, oil prices will recover sooner or later, and the new Baker Hughes company will have technical innovation and service execution of GE allowing it to prosper when oil prices start to climb.

The new Baker Hughes will be the world's largest Oil & Gas Equipment & Services company by sales with revenue of about $32 billion, higher than the present largest oilfield services company Schlumberger (NYSE:SLB) which had revenue of about $30 billion in the last four quarters. Moreover, the combined company is expected to realize synergies of $1.6 billion by 2020, and according to GE, the transaction is projected to add about $0.04 to its earnings per share in 2018, and $0.08 by 2020.

Latest Quarter Results

On October 21, General Electric reported its third quarter 2016 financial results, which beat earnings per share expectations by $0.02 (6.7%). GE's revenues of $29.3 billion for the quarter were slightly below the consensus estimate of $29.7 billion. The company showed significant earnings per share surprise in all its last five quarters, as shown in the table below.

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In the report, GE Chairman and CEO Jeff Immelt said:

"Our strength as a diverse, Digital Industrial company continues to enable us to deliver in a slow growth, volatile environment. This quarter, our teams earned $0.32 of earnings per share with strong performance in Power, Renewable Energy, Aviation, and Healthcare."

The company achieved an impressive growth in the third quarter in orders and backlog. Orders increased by 16% compared to the same quarter a year ago to $26.9 billion, of which 6% were organic, and 10% were due to the Alstom acquisition. The company's backlog grew 18% YoY to $319 billion, of which 6% were organic, and 12% were due to the Alstom acquisition.

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Source: GE Q3 2016 EARNINGS

General Electric Stock Performance

The GE stock has underperformed the market in the last few years. Year to date, the GE stock is down 5.91% while the S&P 500 index has gained 4.28%, and the NASDAQ Composite Index increased by 3.17%. Since the beginning of 2012, GE stock price has grown only 63.65%. In this period, the S&P 500 Index has increased 69.49%, and the NASDAQ Composite Index has risen 98.31%. According to TipRanks, the average target price of the top analysts is at $35, representing an upside of 20% from its November 7 close price of $29.31, which appears reasonable, in my opinion.

Valuation

According to its valuation metrics, GE stock is not cheap. However, considering its estimated high EPS growth rate for the next five years of 12.1%, GE's stock is attractive, in my opinion. The trailing P/E is at 25.27, and the forward P/E is at 17.55. The price to sales ratio is at 2.13, and the price to book value is at 3.19. Furthermore, the price to cash flow ratio is at 17.05, the Enterprise Value/EBITDA ratio is at 23.18, and the PEG ratio is at 1.57.

Dividend and Share Repurchase

Investors in GE stock can also enjoy the generous dividend currently yielding 3.23%. The payout ratio is at 109.52%, and the annual rate of dividend growth over the past three years was high at 9.5%, and over the past five years it was very high at 14.9%.

GE had cut its dividend payment in the years 2009, 2010, as a result, of the 2008-2009 global financial crisis, but had started to increase its dividend payment again in 2011. GE said that it plans to maintain its dividend at the current level in 2016 and grow it after that. GE's board has authorized a repurchase program of up to $50 billion in common stock. The company is targeting to return $32 billion to shareholders between 2016 and 2018 through stock buybacks and increasing dividend payments. GE expects to reduce its share count by 8.0-8.5 billion by 2018.

Conclusion

As I see it, combining with Baker Hughes to create the new mega oilfield services company is a smart move by GE. After all, oil prices will recover sooner or later, and the new Baker Hughes company will have the technical innovation and service execution of GE allowing it to prosper when oil prices start to climb. GE's stock is not cheap, but it is not expensive either, and its average annual estimated EPS growth for the next five years is high. Moreover, GE generates strong cash flow and returns substantial capital to its shareholders through stock buyback and increasing dividend payments. The average target price of the top analysts is at $35, representing an upside of about 20% from its November 7 close price of $29.31, which appears reasonable, in my opinion.