GE: Improving Baseline With More Focused GE Capital

| About: General Electric (GE)

General Electric Company (NYSE:GE), with a market cap of $239.26B, is a diversified technology and financial services company and a leader in all markets in which it competes. While all industrial segments had positive earnings growth with expanding margins in the last quarter, the progress of GE Capital (which comprises around 28.6% of GE's value currently) had significantly improved GE's bottom line in the past 2 years.

Improving GE Capital, Declining ENI Balance and Improving Earnings

The management continues to shrink GE Capital while improving its quality. GE uses ENI, Ending Net Investment, to measure the size of GE Capital segment. Investors should monitor ENI Balance to quantify how GE is performing against its previously communicated goal to reduce the size of financial services segment.

Below is the detail for GE Capital's ENI as of Q4, 2012:

(Click to enlarge)

In the past 2 years, ENI had declined from $461B to $419B and achieved progress every quarter. The GECC Tier 1 common ratio had also improved from 9.9% in Q1, 2011 to 10.2% in Q4, 2012. Most importantly, the earnings had improved from $6.6B in 2011 to $7.4B in 2012, with the breakdown seen in the table below.


GECC Tier 1 common ratio

Ending ENI balance

Q4, 2012




Q3, 2012




Q2, 2012




Q1, 2012




Q4, 2011




Q3, 2011




Q2, 2011




Q1, 2011




New Deals

GE Capital is moving in the right direction with shrinking ENI balance and improving earnings. GE Capital continues to make new deals:

On March 21, 2013, General Electric's finance unit agreed to buy an Australian commercial lending subsidiary of Allianz SE for an undisclosed amount. As said by Aaron Baxter, GE Capital's head of commercial finance in Australia, "The acquisition of the Allianz Finance business allows us to deliver on our strategy of growing our commercial finance offering to this segment."

On March 25, 2013, GE Capital Corporate Finance announced it is syndication agent on a $225M senior secured credit facility to Federal Signal Corporation (NYSE:FSS). The funds refinance debt and will be used to support ongoing working capital needs.

On March 27, 2013, GE Capital Franchise Finance provided $11.3M to Ghai Management Services, a Burger King (BKW) franchisee. The funding was used for the acquisition of six Taco Bell locations in Northern California.

Lastly, as reported, GE financial services arm talked with Dell Inc. (NASDAQ:DELL) recently about buying the computer maker's financing unit, even though the talks didn't lead to a deal. The talks were separate from talks GE has been having with Blackstone Group LP (NYSE:BX), the private-equity firm that is proposing to take control of Dell. Dell's finance arm, valued at $5B, is profitable and could help offset the amount of debt needed to take control of Dell.

What's Next for GE Capital

Despite the focus for GE to slim down GE Capital, GE Capital continues to invest in businesses including lending and leasing to companies, consumer financing, and private-label credit cards. As quoted by Nigel Coe from Morgan Stanley, "GE will continue to suffer a discounted multiple vs. large cap industrial peers given material GECC EPS contribution. Actions to shrink GECC by distributing surplus capital to the parent (the right strategy, in our view) will likely put an upward bias on the multiple over time, but at the expense of more sluggish EPS growth since GECC earnings will shrink." The best strategy is to "improve-quality-and-reduce-quantity," which is exactly what GE is progressing on. GE should continue to shrink its mortgage business and reduce commercial real estate holdings as it continues to scale back GE Capital, which it wants to generate no more than 30 to 40 percent of its profit.

As the economy continues to stabilize and consumer confidence improves, GE Capital may once again help GE's share performance, and this time with a much better risk profile.

Fundamentally, GE has higher net margin of 9.3%, as compared to the industry average of 8.8%, with below the industry average valuation. GE's P/E, P/B and P/S of 16.6, 2.0, and 1.7 are lower than the industry average of 21.7, 2.6, and 1.5. GE's Forward P/E of 11.9 is also below the S&P 500's average of 13.9. GE continues to generate strong operating cash flow of $31.33B with a levered free cash flow of $27.83B.

Bottom Line

GE remains a solid long-term holding with improving GE Capital and growing industrial segments. GE remains undervalued and analysts currently have a mean target price of $25.53 for GE. Investors can review the following ETFs to gain exposure go GE:

  1. Industrial Select Sector SPDR (NYSEARCA:XLI), 12.14% weighting
  2. Dow Jones U.S. Industrial Sector Index Fund (NYSEARCA:IYJ), 11.61% weighting
  3. SPDR S&P 500 Value ETF (NYSEARCA:SPYV), 3.58% weighting

Note: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.