General Electric: Not Quite a Value Trap, More Like a Value Pit 39 comments
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This weekend, Barron's published its annual market prediction survey (subscription required) open to its readers. #11 is always a tough one for me: Which Dow Jones Industrial Average member will perform the worst in the coming year? I said JP Morgan (JPM) last year, and it wasn't even close.
The biggest loser was American International Group (AIG), which was booted and is down 97%. Of the remaining DJIA members, General Motors (GM), not surprisingly, is down the most. At least I did better on my pick for the best one, Johnson & Johnson (JNJ), which should end the year in 3rd or 4th place.
I don't spend a lot of time or effort analyzing large companies, but it is important to have a feel for their prospects due to their large contribution to the broad markets in terms of market capitalization as well as economic impact. While 2008 was a year that saw the demise of one "general" (GM), which actually was my pick for the Barron's contest due to my expectation that the equity gets totally wiped out, 2009's most devastating loss could come from its other "general", General Electric (GE).
GE didn't exactly have a great year this year, as it is down almost 57% despite an infusion from Warren Buffett. It has actually been a while since GE had a good year, as it has declined in each of the three previous years as well, underperforming the S&P 500 quite substantially along the way, especially this year (its first double-digit negative relative performance, most of which has transpired in just this quarter).
From a big picture perspective, GE, the traditional epitome of earnings stability, hinted at serious underlying challenges in the summer, when it missed. Analysts and investors, who for years have sought more disclosure regarding the massive GE Capital unit, began to question a little harder. GE then surprised the market by selling stock into a huge down bid, and it has suffered since then. While the stock has bounced, it hasn't made up much of the losses relative to Industrials in general, trading more like a Financial. Relative to the broad market, the stock sits near its lows, as you can see in the chart below (click to enlarge).
You might look at the chart and conclude quickly that GE is extremely cheap. After all, the price hasn't been this low since 1997, it has underperformed the rest of the market rather substantially since the 2000 peak (and is back to 1995 relative levels), its PE bounced off of a 20-year low and its P/B is the lowest it has been in decades (and close to the magic 1X). No one has been showing this company any love!
In a bull market, when you try to play "mean-reversion", you can get stuck in a value trap. The stock is cheap for a reason and fails to participate in a rally. In a bear market, though, you can fall into a value pit. Every single failed financial was cheap and lauded as such before it was wiped out. Ask Bill Miller, Rich Pzena or practically any investor in Financials over the past year. I even confess to succumbing to the siren's call for the GSEs.
So, why do I think that GE might actually be more of a "pit" than a "trap"? Last week, I warned investors to steer clear of companies with "big bad balance sheets", briefly citing GE as an example. The balance sheet is horrible, and faith in the company is rapidly waning. As I will highlight below, they have a ton of debt, much of it short-term. They had attempted to sell some assets, but they suspended those efforts. Perhaps my thesis is too simple, that this massively leveraged company could struggle with liquidity, but take a look at the chart below (click to enlarge) to get a less rosy view of this great American icon:
While many may believe that "GE is worth less today than it was over a decade ago", it's simply not true. The equity value certainly has declined, but the enterprise value, which adds the net debt, has increased dramatically and isn't too far from its all-time peak in 2000. Make no mistake: GE has continued to party like it's 1999 until very recently, when it found its new religion (shrinking GE Capital). Now the debt-holders control a much larger piece of the pie than the equity-holders. As you can see above, this massive expansion of the balance sheet has hurt the return on capital while keeping return on equity at a high-double digit level. Here is what the balance sheet transformation looks like:
Note that these numbers precede both the equity sale as well as the preferred sale, so the liquidity is better than it appears. Still, though, the rapid expansion of GE Capital is quite evident, it leaves the company with little flexibility in any downside scenario. Tangible equity is now dwarfed by its overall debt burden (share repurchases at high prices as well as acquistions).
GE's industrial business, which is global in nature and extremely diversifed, should ordinarily weather isolated storms well, but this is no ordinary storm. Even without the potential credit problems from GE Capital, the core business should struggle. The weak balance sheet takes flexibility away from the company - no share repurchases, perhaps a slashed dividend (despite their maintaining otherwise), inability to potentially take advantage of other asset sales, etc.
It's no wonder that the company has been so aggressive in raising capital lately. The rating agencies, just slightly behind the eight-ball, have finally figured out that perhaps GE isn't really AAA quality. Weak fundamentals, pressure from the balance sheet, and challenging capital markets could make 2009 yet another year that GE shareholders will want to forget.
Disclosure: No position in GE
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This article has 39 comments:
I would propose that everyone in Seeking alpha start a ratings agency of our own. After all, we couldn't be worse than the ones in existence could we? Rather than AAA and other ratings a ratings agency should place a fixed percentage chance of a default. If they were really good they should be willing to sell bankruptcy insurance based on those odds. That would put skin in the game. And as we learned from the mortgage mess, if there is no skin in the game you can't really be that trusted can you, especially when you are paid to bias yourself in favor of the companies debt you rate.
Please, how long will they assume the public is comprised of all absolute fools?
To Senior Management at GE Capital...stop thinking about YOU only and think about the sacrifices that your employees made for working 24/7 to get the job done...or let me say to make believe "The Pitches" for your meetings look good in GREEN and not in Red and Yellow. Let's be honest...STOP saying that GE is a AAA company....Sherin at your webcast meetings you statement totals of revenues of $*(**(*(*& NOT INCLUDED SO AND SO...The share holders would be in shock to actually see the correct totals. I hope GE will not turn in a Bernardo Madoff matter.
On Dec 29 03:08 AM constructe wrote:
> Very good well rounded analysis. Thanks. I also agree, GE is not
> healthy at all, but I think everyone knows that besides the ratings
> agencies that have become the morticians of the stock market (They
> only make a n appearance when the patient is dead).
>
> I would propose that everyone in Seeking alpha start a ratings agency
> of our own. After all, we couldn't be worse than the ones in existence
> could we? Rather than AAA and other ratings a ratings agency should
> place a fixed percentage chance of a default. If they were really
> good they should be willing to sell bankruptcy insurance based on
> those odds. That would put skin in the game. And as we learned from
> the mortgage mess, if there is no skin in the game you can't really
> be that trusted can you, especially when you are paid to bias yourself
> in favor of the companies debt you rate.
>
> Please, how long will they assume the public is comprised of all
> absolute fools?
>
the stock price is low, the dividends are still high,
why is this a bad stock to buy now, and keep for 20 ~ 30 years?
The pitiful GM balance sheet even improved significantly when they sold controlling interest in GMAC and no longer had to include it in their consolidated statements.
On Dec 29 08:54 AM Dr.Jackpot wrote:
> GE's lights will be burning after all the others are out. The world
> can't exist without GE.
What the current economic crisis has produced is a lack of patience and a bias that everything will fail. That actually is the important good news -- it means that though bad times continue for the foreseealbe future, such negativity is the sure sign of better times are ahead for those with patience and knowledge that things are never as bad )or as good) as they seem.
On Dec 29 09:51 AM bocaj21 wrote:
> Alan's comment is well researched and a good analysis. But he then
> extrapolates illogical conclusions from his data. For one thing,
> he implicitly makes non-analogous comparisons between the balance
> sheets of GE and GM. True, GE shareholders will likely have a tough
> go this coming year, but to intimate that GE could fall into "the
> pit" in 2009 like GM did in 2008, is analyticallly nonsense, given
> that it intimates not only a short-term rocky road, but possible
> demise of a respected global company (in no way like AIG). GE certainly
> will survive the current world economic crisis, though a leaner company
> with less emphasis on GE Capital will result. In the long run that
> is good news for equity holders.
>
> What the current economic crisis has produced is a lack of patience
> and a bias that everything will fail. That actually is the important
> good news -- it means that though bad times continue for the foreseealbe
> future, such negativity is the sure sign of better times are ahead
> for those with patience and knowledge that things are never as bad
> )or as good) as they seem.
On Dec 29 09:51 AM bocaj21 wrote:
> Alan's comment is well researched and a good analysis. But he then
> extrapolates illogical conclusions from his data. For one thing,
> he implicitly makes non-analogous comparisons between the balance
> sheets of GE and GM. True, GE shareholders will likely have a tough
> go this coming year, but to intimate that GE could fall into "the
> pit" in 2009 like GM did in 2008, is analyticallly nonsense, given
> that it intimates not only a short-term rocky road, but possible
> demise of a respected global company (in no way like AIG). GE certainly
> will survive the current world economic crisis, though a leaner company
> with less emphasis on GE Capital will result. In the long run that
> is good news for equity holders.
>
> What the current economic crisis has produced is a lack of patience
> and a bias that everything will fail. That actually is the important
> good news -- it means that though bad times continue for the foreseealbe
> future, such negativity is the sure sign of better times are ahead
> for those with patience and knowledge that things are never as bad
> )or as good) as they seem.
GE is widely owned by pension plans and especially by individual retirees. I call these people Grandma Millie. They don't care all that much about capital appreciation but really need GE to keep paying consistent dividends. If the dividend is cut (ignore for the moment whether this is necessary or a good idea), not only will they not get their monthly checks but they'll also lose another 20-40% of their capital. From a political perspective, that's simply unacceptable. Remember that Grandma Millie is a pathetic figure, and she also votes. GE Capital (the real problem here anyway) is already a bank and will get as much government money as GE requires to continue paying out. The government has shown no inclination at all to let companies like this fail; GM is in drastically worse shape and is both far smaller and less widely held than GE but is still being saved at great but largely unknowable cost.
Remember, Grandma doesn't care much about dilution and frankly neither should you: we're talking about a yield north of 7%. Worst case, you pocket that income for a few years while the balance sheet is cleaned up courtesy of the taxpayers, then you recover the rest of your capital when business conditions improve. Considering that this yield is around 3x what you can get in Treasuries (and is tax-preferred, at least for a little while), the risks would have to be enormous to justify staying away. There are four basic outcomes possible here: total loss, dividend suspension for 3 years, dividend cut to 20c and left there for 3 years, and no change. What probabilities are you assigning to these outcomes that justify your bearishness? Remember, we're comparing this with other 20-30 year investments like the Long Bond. Even if we assigned these pessimistic probabilities like 10%, 30%, 50%, and 10%, you're still way ahead (as a reminder, a 20c dividend would imply a yield just under double that on the long bond).
Of course, even without a bailout, GE has several quality businesses and remains quite profitable (more than enough to cover the dividend). It's not out of the question that it will survive in its current form without any help at all. Some of their business units also stand to benefit from infrastructure investment, and there are some longer-term global growth themes here to boot.
I didn't like GE at 30. I bought some below 20, and I'm buying more now. Despite the risks, which are real, there are too many ways to profit by owning this company to ignore it as a value pit. And the price, finally, is right. It's not clear to me that there's much scope left for profitable shorting here, but maybe you could squeeze out just a bit more profit. But where do you exit? This sucker ain't going to zero. The short-term picture here is very murky; longs and shorts could each find themselves losing 25% in a 3-month period. And your own disclosure tells me you see it the same way, even while you're bashing. The long-term picture is not murky at all; this is a profitable company with good growth prospects that already has almost unlimited access to government money and is widely held by a politically strong voting bloc.
If I still haven't convinced you, at the very least you should be buying the notes. I can see absolutely no excuse for avoiding those. Even if they end up getting downgraded, so what? It's not like you aren't going to get your principal and interest. The real worry you should have with both the stock and the paper isn't that GE stops paying you but that what they pay you might no longer be worth anything. Offset that risk by shorting the Great Treasury Bubble.
I'll follow Buffet anytime before you....LOL
Any company that is paying 10% plus conversion options to borrow money is on its last leg. GE may be a familiar brand name, but as the author points out, it consists mostly of debt. A lot of people never thought GM would get to the point it is at today. It was just too big, too well known, still paying dividends. I think the comparison is appropriate.
Recent CandleStick Analysis
Very Bullish
Date Candle
Dec-24-2008 DOJI
Support/Resistance
Type Value Conf.
resist. 29.85 4
resist. 29.11 4
resist. 28.14 2
resist. 27.69 2
resist. 25.92 4
resist. 22.24 4
resist. 20.77 2
resist. 19.14 8
resist. 17.66 7
resist. 16.33 9
supp 14.16 2
Next resistance is $16.33 time to load up when....Seeking boys are tell you to sell....now Techical analysis can really help you better...LOL
On Dec 29 07:25 AM coffeeman wrote:
> But wont Ge return to his goldern status in the future?
>
> the stock price is low, the dividends are still high,
> why is this a bad stock to buy now, and keep for 20 ~ 30 years?
>
>
On Dec 29 01:47 PM Chris B wrote:
> GE is mostly a financial company with secondary revenue streams from
> licensing their brand name to Chinese manufacturers and a few actual
> industrial businesses. Forget about light bulbs and washing machines.
> GE hasn't gotten most of their revenues from making products in a
> long, long time. Forget the image of a factory - think auto loans,
> insurance, and brand name licensing.
>
> Any company that is paying 10% plus conversion options to borrow
> money is on its last leg. GE may be a familiar brand name, but as
> the author points out, it consists mostly of debt. A lot of people
> never thought GM would get to the point it is at today. It was just
> too big, too well known, still paying dividends. I think the comparison
> is appropriate.
When I was young (40 years ago) ignorant as I was I came to revere GE as the kingpin in making light bulbs and home appliances. The world of electrical and electronic engineering was one of the hottest and fastest growing technology fields to enterprise in. And I was stupid enough to graduate in EE with two degrees.
Sadly, since then I believe they dabbled in Aerospace (Satellites) - sold out to Lockheed; they missed the boats in computers, telecommunications, audio and video consumer electronics, the wireless mobile revolution, video games, the Internet, and without blush on its face called itself a Conglomerate. What a cop out!
A few years ago when a repair man came to fix our GE washer, he jokingly commented that the GE Brand was the least reliable in the market (hear say only, I disclaim any liability). Seriously I do place a lot of credence in the guys on the street, for street critique is foremost authentic in my book.
And you saw this guy Jack Welch talking like an evangelist on TV time after time, authoring best-selling books on how to move people --- You've got it --- America's obsession and infactuation with charisma and addiction to Hollywood at its best.
It it time for another one to fall.
On Dec 29 11:07 AM sr9web wrote:
> So the author expects GE to drop below $12.50 in 2009?
This is insane behavior.
Stocks in Europe, Asia, U.S. Futures Gain; Arcelor, GM Rise
Email | Print | A A A
By Adria Cimino
Dec. 30 (Bloomberg) -- Stocks in Europe and Asia climbed, trimming the MSCI World Index’s worst annual decline on record, as governments stepped up measures to boost the global economy. U.S. index futures advanced.
ArcelorMittal, which was valued last month at the cheapest on record relative to earnings, added 2.3 percent. General Motors Corp. jumped 10 percent in Germany as the U.S. Treasury committed $6 billion to support the automaker’s financing arm. Chi Mei Optoelectronics Corp., Taiwan’s second-biggest liquid- crystal display maker, surged 7 percent after the government pledged $6.1 billion to combat the financial crisis.
“To see the U.S. supporting a company like GM is positive,” said Kilian de Kertanguy, a fund manager at Cholet- Dupont Gestion in Paris, which oversees about $2.3 billion. “There isn’t much activity this week, however, so the market is rising in a vacuum.”
The MSCI World Index climbed for a fourth straight day, adding 0.2 percent to 902.67 at 12:20 p.m. in London. Futures on the Standard & Poor’s 500 Index gained 0.6 percent.
The MSCI World has dropped 43 percent this year as credit- related losses and writedowns at financial firms that topped $1 trillion pushed the U.S., Europe and Japan into the first simultaneous recessions since World War II. The gauge of stocks in 23 developed nations is now valued at 11.7 times the earnings of its 1,693 companies, compared with an average ratio of 26.5 this decade, data compiled by Bloomberg show.
As far as the dividend goes, it's probably one of the cheaper ways to capitalize debt by retaining shareholders instead of fundraising when they peel off because of a dividend cut. After all %7.92 probably isn't that bad of a deal for a legitimate loan.
I agree their washing machines suck, but, their jenbacher engines don't. I can relate in my mind this whole "crisis" is much like a hard winter, and much like an animal must have a healthy layer of fat to survive it so must companies. Their capital peers have been laid to waste and artificially kept on life support via tarp money (yes I know they are getting it too) much like a wounded deer that an animal lover will nurse back to health so it can go play in traffic another day. I guess the question is "do you feel lucky punk!" If the value pit is 1000 feet deep we need to see the bottom bcause if we have only fallen 900 feet down it the 100 remaining feet could still kill you. Or have we fallen 995 feet and this is it who knows. It is kind of sad to see a stalwart "safe" investment reduced to a "speculative" play.
A lot of the fears you are talking about are already priced in at the stock price of >$16. I think GE is worth closer to $30. There is a high probability this price will be realized when the recession is over and growth resumes in 2 to 3 years.
GE is extremely well positioned, and in fact embedded in the giant emerging economies like Brazil, India and China. It is also a great infrastructure play and should benefit from the stimulus. It is also one of the biggest health care companies.
Also GE is likely to monetize its valuable assets like NBC and appliances when the market recovers. It will likely reinvest the proceeds into emerging markets.
But by then, it may be a strong buy, depending on how the prospects for true global recovery are shaping up.
I wouldn't touch it until it sinks under $10 - that will shock a lot of idiots like Bill Miller and Vince Farrell - and lead to a blowoff to the downside. But GE is not a zero (at least, I don't think so) and could be a great trade from $5 back to $12 or whatever, depending on your gambling spirit. Be very patient with this one, and wait for the $5 range - it is coming, for sure.
too large to fail.
Yes they are getting out of consumer appliances, but that's a good thing. Even the crapmeisters in Shenzhen are starting to get their ass handed to them in that market. Pretty soon, no one will be able to make any money making and selling appliances.