General Electric: A Good Decision!

Aug.30.13 | About: General Electric (GE)

The headlines on the front page of the Wall Street Journal read, "GE Set to Exit Retail Lending." The article highlights some very important reasons for the move. Since Jeffrey Immelt, GE's (NYSE:GE) chief executive officer, took over at General Electric, the company's stock is down about 40 percent. The S&P stock index is up about 50 percent over this time period.

Even more devastating is the fact that the performance of the stock of two comparable organizations, industrial conglomerates, Honeywell International, Inc. and United Technologies Corp., have performed much better. Over the time period Mr. Immelt has been at the helm of GE, the WSJ reports, "Honeywell's shares are up around 125 percent and United Technologies is up about 200 percent."

And, these latter two conglomerates have not engaged to any degree in the financial end of the business.

Historically, GE moved into the finance area along with other big American manufacturing companies like General Motors. GE made consumer goods and it made sense that it could not only help its manufacturing wing by creating credit for people to buy its goods, thereby increasing company sales, but it could also benefit from fees and interest earnings from the actual financing of the products.

Then came the credit inflation of the last fifty years. Like many other businesses in the United States, the government's promise of a continual inflation of credit during this period provided incentive for companies to take on more risk, to use more and more financial risk, and to finance longer-maturity assets with short-term liabilities. And, it encouraged these organizations to innovate in the financial area.

General Electric did all four of these things… and did them well.

And, General Electric benefited from this effort; the company was earning more than 50 percent of its profits from its financial wing. Furthermore, the earnings were relatively steady and smoothed out the performance of the company over time.

Even now, GE is earning more than 45 percent of its profits from the company's lending business. In terms of loans and other assets, the financial side of the business would rank as the fifth largest commercial bank in the country.

How much this performance detracted from its manufacturing business is hard to say. Certainly receiving so much of its profits from the financial side and the fact that these earnings flows were relatively stable could certainly have lulled management from being as effective as it might have been on the production side.

One could argue that investors believed that GE was not doing as well on the manufacturing side as Honeywell and United Technologies and these investors reflected it in the marketplace.

Mr. Immelt has wrought changes at General Electric. He has, according to the Wall Street Journal article, positioned GE "as a global infrastructure manufacturer focused on complex, bit-ticket items such as locomotives, jet engines and gas-fueled power generators. He has shed businesses that fall outside of that mandate, including entertainment arm NBCUniversal, the company's plastics, and its reinsurance business."

He has stated that he "would like earnings from the industrial businesses to account for 65 percent of the company's earnings by 2015, up from about 55 percent in the quarter ended June 30."

This obviously means that Mr. Immelt would like the financial side to shrink to at least only 35 percent of company earnings.

The plan is to separate off GE's credit card business through an initial public offering. The bankers working on the possible offering seem to be JPMorgan Chase & Co. and Goldman Sachs Group, Inc.

An IPO should bring in a substantial amount of money. The spin-off is a good producer: according to Michael Neal, who retired as the head of GE Capital in June. In the WSJ article, Mr. Neal claimed in May "that the private-label credit card business had a return on equity of 50 percent."

This would, I believe, be very good for Mr. Immelt and for General Electric. The times have changed. The current credit inflation now taking place is creating short-run distortions and not a stable framework to bail-out financial extensions.

The business plan of GE has changed. It is time for the CEO and the company to move on into the future.

The world economy is not growing at a very robust pace… and this pace is not really expected to pick up in the near future. General Electric needs to focus on what it does and not have any distractions from its financial wing keeping it from doing the best it can. I believe that this move is in the right direction and should help GE stock perform better in the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.