The Bull and Bear Cases for GE

On Tuesday, options trading on General Electric was very hectic. Recently, we’ve seen investors continue to bet on the untimely demise of this American industrial bellwether. According to OptionMONSTER, we saw a flurry of activity toward June 2.50 put options on Tuesday, March 3rd. Moving deeper into this figure, normal levels would yield volume of 41,963 contracts, but we saw a staggering volume of 81,740 contracts traded on the day. As GE (GE) leads the financial sector lower, the question remains… should GE be leading the financial sector lower!?

There are no two ways about it, General Electric is far off of its historic highs in the low $40s, as shares closed Tuesday at a mere $7.01 (after falling to a low of $6.85 intraday). Perhaps we can admit that much of the sell-off was for good reasons. Heck, we can fairly classify the company as a sub-$15 equity holding in this environment. But is GE under $10 a case of severe pessimism that should be largely regarded as a buying opportunity and a blessed valuation from a pained market? Or are we simply facing yet another value trap?

To answer this, let’s have a look at the short-term and long-term prospects of holding GE:

The Bull Case:

The only problem with General Electric in this market is that it has lost some of its “street credit” by moving 40% of its revenue stream toward GE Capital. In fact, if we wanted to value the entire unit at $0, we should still reach an intrinsic valuation above $8 a share. Is GE Capital really in such bad shape? After all, the unit made a hefty $8.6 billion in 2008 and is projected to pull in another $5 billion in 2009, even through this environment. Most of its assets are long term regardless… so should we really hold the company to the same standards that we do Citigroup (C)?

Management under CEO Jeffrey Immelt should be considered a driving factor for holding the firm above the puny 4.0x P/E multiple that shares are currently commanding. General Electric has essentially two credit woes that have been highlighted in the news as of late: the dividend and the credit rating.

Last week, GE announced a plan to trim the dividend payout to $0.10 a share starting in the third quarter of 2009 (the first quarter it can do this based on an old dividend plan). This is a net positive as far as I’m concerned, since it shows that management is more focused on shoring up the books than appeasing the few shareholders that still regard a dividend payout in high esteem (regardless of the fact that a $30 stock is now practically trading on the pink sheets). Additionally, while Moody’s has made it clear that GE’s AAA credit rating is still under review, a cut to AA wouldn’t materially affect the debt structure, because this is where GE’s unsecured debt issues have already been priced.

Because GE is on pace to alleviate the bad asset exposure over time, with a long-term financial restructuring plan that seems to be well on track, should investors not be turned to the future? With more than half of its bookings coming from industrial companies, where there is a backlog of $51 billion in equipment and $121 billion in service agreements, General Electric is making money. Furthermore, President Obama’s stimulus plan could lead much of GE’s “Ecomagination” unit in particular to big jumps in profit, as the energy efficient focus will drive revenues through Obama’s electric grid among other projects.

Under $10? Let’s get serious. Unlike the banks that GE trades with, it is making billions in profit every quarter… and this train shows no signs of slowing. Clearly, there is a disconnect between reality and trading activity. Buy GE.

The Bear Case:

Does it really matter what General Electric does anymore? The answer: probably not. Investors in this environment are taking extremely bearish positions on shares of GE. As we discussed options trading above, it is clear that many investors are willing to take bets to drag shares lower on speculation. No longer does it matter where long term investors price GE’s assets, because we seem to be experiencing a virtual “run on the bank” for a company that has too much financial leverage for its own good.

On the one hand, General Electric is making strides to shore up its balance sheet. However, let’s consider that the strategy includes restructuring much of the debt in such a way that has the company promising $133 billion of debt maturities coming due in 2009. Additionally, while General Electric’s fourth quarter conference call marked leverage ratios at 7:1, with a targeted 6:1 by the end of the first quarter 2009, we can have a look at its long term debt position of roughly $523 billion and call out a leverage number closer to 60:1. Sure, the company has reduced its exposure to commercial paper, but it still has around $70 billion lurking on its books.

The problem of trust is yet another issue. A large disconnect between what Immelt asserts, and what GE’s actions later yield, is becoming almost too much to bear. Example one lies in the assertion that the dividend was “safe,” until management ended up announcing plans to eliminate most of the yield one month later. The problem many investors have with GE is that nobody knows when the bad news is fully out and accounted for. After issuing profit warnings two times between its 3Q08 and 4Q08, it still missed consensus estimates for the most recently reported. Moreover, General Electric has very suspect markings for “goodwill” and other intangible assets that far outweigh tangible items. Finally, a dangerous exposure to financing in Eastern Europe could very much blow up in its face, and it would lose much of its receivable bookings on potential defaults.

Under $10? Don’t be surprised. The fact that its financial unit is still largely an enigma to accountants around the world and that traders have a vice-grip on this company’s shares (intent to sell them lower), leads me to believe this firm still merits a short position. Sell GE.

The Victor?

I am of the conviction that while shares of General Electric are highly susceptible to a bear market bounce, we will see the company consolidate to the downside over the next month. When hedge funds and leveraged short sellers are pouring capital into this downward-momentum trade, it is tough to bite the bullet and begin building up a long position.

However, I remain convinced that this all-American conglomerate will see recovery starting in the second half of 2009. The victor may be different depending on whether you take a short or long term view on investing in the stock. For the short term, GE is more than likely going to continue its volatile path; however, I would be cautiously building up a holding in General Electric anywhere under $10 a share and adding on the way down for longer term success.

Comments

[Mad Hedge F...:]

I tink what is going on in GE is unbelievable. One out of five stocks in the S&P 500 has a single digit price. General Electric (GE) hit the $5 handle. Amazing. This is a company that has $45 billion of cash, $60 billion in back up government financing, and has already rolled over 70% of its long term debt due this year. GE Capital will be profitable this year, because only 2% of its holdings are subject to market to market rules. CFO Keith Sherin says the only explanation for a share price that is a hat size is the rampant fear now sweeping the markets.

Mar 05 01:05 PM

[Jim Regan:]

I definitely agree with this, but you need to remember that the markets are largely trading on fear more than logic at this point. One other thing to point out (I wanted to keep the article concise) is that they don't mark to market most of their assets, as you have pointed out. I remember on their fourth quarter conference call, Immelt talked about their real estate portfolio. For one reason or another, everyone is concerned about this side of their business... but they are investing in real estate for the long run. They actually buy it to take money from tenants and improve the buildings... it's not stuff that they are flipping and buy/selling like a hedge fund or investment bank.


On Mar 05 01:05 PM The Mad Hedge Fund Trader wrote:

> I tink what is going on in GE is unbelievable. One out of five stocks
> in the S&P 500 has a single digit price. General Electric (seekingalpha.com/symbo...)
> hit the $5 handle. Amazing. This is a company that has $45 billion
> of cash, $60 billion in back up government financing, and has already
> rolled over 70% of its long term debt due this year. GE Capital will
> be profitable this year, because only 2% of its holdings are subject
> to market to market rules. CFO Keith Sherin says the only explanation
> for a share price that is a hat size is the rampant fear now sweeping
> the markets.

Mar 05 02:14 PM

[Titus Andro...:]

Good work Jim. GE wins long term! I think 2009 might be a little early. Time will tell. Just sold one of my houses and will invest most in GE throughout 2009. Please tell me thats an old high school photo of you. If not, you just changed my opinion of todays youth. Keep up the good work.

Mar 05 04:16 PM

[jstratt:]

A tip of the hat to you for a fine balanced review!

Mar 05 08:38 PM

[Jim Regan:]

Thanks for the kind words Titus,

I am currently a sophomore at Penn State and run a company with a few of my colleagues at BullishBankers.com. If you like our stuff, we'd love for you to swing by and see our official community.

-Jim

On Mar 05 04:16 PM Titus Andronicus wrote:

> Good work Jim. GE wins long term! I think 2009 might be a little
> early. Time will tell. Just sold one of my houses and will invest
> most in GE throughout 2009.
> Please tell me thats an old high school photo of you. If not, you
> just changed my opinion of todays youth. Keep up the good work.

Mar 15 02:27 AM