19-FEB-09 - General Electric (GE) Increasing non-earning assets without commensurate charge-offs, dramatic decline in industrial orders and excessive leverage leads to high likelihood of credit rating cut and dividend cut. Initiate coverage with SELL rating.
INVESTMENT THESIS
- GE is over leveraged with a net tangible book value that is only 1% of total assets.
- GECS non-earning assets increased 19.5% sequentially in Q4:08. The delinquency rate has been increasing throughout 2008.
- Low interest coverage and declining EPS create risk to the AAA credit rating. We believe both a credit rating cut and a dividend cut are likely in 2009.
- The worldwide recession highlights the company’s archaic business model. GE has been using increasing leverage to prop up financial performance.
- We forecast a revenue decline of 5% in 2009 and EPS down 63.8%. Slowing industrial orders and charge-offs at GECS drive EPS lower.
RISKS
- The worldwide recession may end sooner than we expect.
- The US fiscal stimulus plan may cause the US economy to rebound more quickly than we expect.
- Other countries may execute fiscal stimulus plans that cause the worldwide recession to rebound quickly.
SUMMARY
General Electric has been a bellwether stock for the equity indices and money managers for many years. The worldwide economic recession, however, is exposing the leverage that supported GE’s financial performance. As a financial services giant, the threat of a deflationary environment not seen since the Great Depression is accentuating the company’s downturn. We expect the EPS decline to put the AAA credit rating and dividend at risk in 2009. Our SELL thesis is based on the company’s high leverage and archaic business model that depends on leverage to improve returns for a far reaching conglomerate.
As an owner of CNBC and the largest investment banking client for Wall Street firms for many years, GE has remained untouchable for Street analysts to bad mouth. Despite GE’s underperformance, there is only one underperform rating from the Street, and no sell ratings by analysts. GE has a history of managing EPS expectations, putting out rosy forecasts at the beginning of the period and managing analysts’ forecasts down through the period so it appears the company does not have a negative EPS surprise. In addition to managing expectations well, GE is very good at managing its earnings. In an abysmal Q4:08, the company reported EPS of $0.38, assisted by a tax benefit of $0.13 per share, enabling the company to meet the lowered EPS estimates of $0.36 – 0.51.
Non-earning receivables in GECS have increased significantly in Q4:08 and we expect this to continue. Just when the financial side of the business is performing poorly, the commercial/industrial segments reported a sharp decline in orders. We believe company guidance for flat to +5% growth in industrial segment profits is overly optimistic. Despite an increase in backlog, orders are down. The recession and credit crunch are likely to keep orders trending down for a few more quarters.
We expect the credit rating and dividend to be cut in 2009. The company has serious liquidity issues and counterparty risks. We initiate coverage with a SELL rating.
