General Electric: Why All the Fuss about AAA?

Union Bank of Switzerland (UBS) issued a 'short-term sell" call on General Electric (GE) Tuesday. But a senior executive of a GE-affiliate in India suggested, with a dose of sarcasm, that the UBS analyst who issued that call should focus on UBS itself. "Rather than confusing investors with flawed recommendations in the current environment, institutions like UBS and Goldman Sachs (GS) should be worrying about their own viability," the executive stated shortly after GE's shares dipped below $12 Tuesday. Goldman had indicated earlier that activity in GE's options suggested a 50% decline in GE's dividends at some point in the very foreseeable future.

The reasons for the concerns surrounding General Electric are well-known: increasing credit losses, a cut in dividends and depreciating foreign assets. But these concerns are already in the public domain and, despite the retention of the "AAA" rating by Standard and Poor's, traders in the debt marketplace have been "implying" a rating downgrade for many weeks now. Quite clearly, an actual downgrade will generate another sell-off in GE's shares; but, in fundamental terms, the risks to General Electric are best captured in its balance sheet and, in that respect, UBS failed to address the substantive issues.

This writer has targeted $10 (and lower) for GE's shares; that target was founded, in part, in the serious "maturity mismatches" (i.e. borrow short and lend/invest long) derived from GE's financial statements. However, it must be conceded that many of the formidable challenges posed by maturity mismatching have been offset by GE's access to the Fed's commercial paper program and to the FDIC's loan guarantees. Today, those short GE's stock need only answer one question: How low will the price go following a downgrade in ratings?

Goldman says that General Electric is now in "show-me" mode. In other words, GE's shareholders should be watching the dividend on a quarter-by-quarter basis. While Goldman estimates fourth-quarter earnings at 36 cents a share, the recent analyst consensus reported by Thompson Reuters is in the 37-44 cents range. GE's earnings report is due Friday and it is highly recommended that investors look beyond the dividend figure and check the fine print in the notes and advisories for guidance.

In brief, this writer does not see any appreciable, immediate downside from the $10 level; and a post-downgrade sell-off will be an opportunity to cover existing shorts. The medium term (mid- to late-2009), however, is an entirely different proposition altogether. More precisely, GE's analysis of its Level 2 and Level 3 assets (per FSAS 157) is open for debate. Domestic assets apart, there is enough evidence to show that GE's foreign holdings, which have been accounting for more than half of GE's earnings and which span a total of 100-plus countries, are due for continuing impairments as the global recession worsens. This is not the forum to launch into a comprehensive review of GE's description of its Level 2 and Level 3 (see last 10Q filing for details); but, as a general rule, a deteriorating economic environment will force higher delinquency provisions.

Furthermore, asset impairments must result in lower dividends. Whether General Electric is able to pay a dividend of 20 cents or 35 cents for the third and fourth quarters of 2009 is an issue which will be settled by the quantum of the qualitative decline in its asset portfolio. In this writer's view, the economic outlook dictates a number closer to the former (20 cents); which, in turn, implies a stock price in the $5-6 range. What is at stake here is the sustainability of GE's diversified business model, in a manner quite akin to Citigroup (C), not simply a credit rating or a partial federal bailout.

So, while shorts on General Electric can no longer be treated as lucrative short-term plays, given the limited-downside scenario portrayed above, the foundations for longer-term short positions are very much intact. Unless, of course, an investor or trader is convinced that the Obama stimulus plan, in conjunction with the numerous rescue packages throughout the world, is going to cause a credible economic turnaround (or verifiable perceptions in that regard) by early 2010, something this writer is not convinced about at all.

Disclosure: Author holds short position in GE, UBS

Comments

[Chris B:]

As I've said before, GE's one competitive advantage is that due to their size, they can finance their big customers with AAA low interest rates. Without this advantage, their smaller, nimbler, and foreign competitors would eat them alive.

If GE loses their access to cheap financing in a futile attempt to prop up the stock price and to use debt to pay dividends, we can expect their earnings to be impaired in the long run, not just the next few quarters. It would be a sad, suicidal end to a company that was once the pillar of American industry.

Jan 22 10:57 AM

[Teutonic Kn...:]

to Rakesh, Ed K, and Chris B:

Let us summarize what had been said so far. Rakesh would suggest that GE would hover around the range of $10-14 over the next 6 months or so. Ed K would say that if the economy in the U.S. and worldwide would further deteriorate in the coming year or thereafter, the stock price would likely drop below $10, at which time the dividend rate would look outrageously high, and a cut would be inevitable. Chris B echoed those sentiments. This sounds logical. So it depends on the economy. No one can tell what the future holds.

Now, question for Ed K: What do you mean by "act now"?

Teutonic

Jan 22 03:24 PM

[Martin G.l:]

G.E. is involved with a number of products that can save fossil fuels. They should fare well since they are being encouraged and probably will be subsidized by the Obama Administration.

Jan 22 05:30 PM

[Rakesh Saxena:]

Yes Yeutonic---the fate of GE's share price rests on the shape of the domestic and global economy in the next few months, particularly in relation to perceptions of asset valuations and dividend capability. Why I'm not suggesting an immediate and sharp downside is due to the fact that the next 1-2 months will see a vigorous debate on the true impact of the stimulus packages--a tug-of-war of sorts. Many thanks - Rakesh


On Jan 22 03:24 PM Teutonic Knight wrote:

> to Rakesh, Ed K, and Chris B:
>
> Let us summarize what had been said so far. Rakesh would suggest
> that GE would hover around the range of $10-14 over the next 6 months
> or so. Ed K would say that if the economy in the U.S. and worldwide
> would further deteriorate in the coming year or thereafter, the stock
> price would likely drop below $10, at which time the dividend rate
> would look outrageously high, and a cut would be inevitable. Chris
> B echoed those sentiments. This sounds logical. So it depends on
> the economy. No one can tell what the future holds.
>
> Now, question for Ed K: What do you mean by "act now"?
>
> Teutonic

Jan 23 01:53 AM

[Rakesh Saxena:]

Dear Martin: Yes, that could be one bright spot for GE. But that, in my view, is a bit of a longer term proposition---providin... support around $6. Many thanks - Rakesh


On Jan 22 05:30 PM Martin G.l wrote:

> G.E. is involved with a number of products that can save fossil fuels.
> They should fare well since they are being encouraged and probably
> will be subsidized by the Obama Administration.

Jan 23 02:04 AM

[Teutonic Kn...:]

Rakesh, thanks for this cue. I owe you one.

Teutonic


On Jan 23 01:53 AM Rakesh Saxena wrote:

> Yes Yeutonic---the fate of GE's share price rests on the shape of
> the domestic and global economy in the next few months, particularly
> in relation to perceptions of asset valuations and dividend capability.
> Why I'm not suggesting an immediate and sharp downside is due to
> the fact that the next 1-2 months will see a vigorous debate on the
> true impact of the stimulus packages--a tug-of-war of sorts. Many
> thanks - Rakesh
>
>
> On Jan 22 03:24 PM Teutonic Knight wrote:

Jan 23 01:19 PM

[Teutonic Kn...:]

Thanks, I appreciate it. Looks like GE needs tough medication real quick...


On Jan 23 11:38 AM ED K wrote:

> Guten tag,Herr Teutonic,
>
> Here it is:
>
> Year over year stock price decline of 66%+,now$12.81,then $38.52

>
>
> " " " net income decline of 44%
>
> " " " eps decline of 47% $.35 versus$.66
>
> The usual things that companies do in tough times would probably
> work,such as,cutting the work force expenses,dividends,exe... pay,etc.

>
>
> I have not heard of GE doing anything to decrease the cost of their
> operations.
>
> I hope this answers your question.Have a great day.
>
> .
>
>
>
>
> On Jan 23 01:53 AM Rakesh Saxena wrote:

Jan 23 01:22 PM