The Wall Street Journal reported recently that General Electric (GE) was progressing on previously discussed plans to divest its U.S. consumer assets, with work under way for an IPO; other options such as smaller spinoffs or asset sales are also under consideration. The conglomerate plans to spin off its U.S. Private Label Credit Card ("PLCC") business as soon as early 2014, as the company moves to focus on its core industrial operations.
The exit of PLCC is a key pillar of the roadmap to shareholder value creation and substantially de-risks the GE story. GE Capital and particularly PLCC are undervalued assets in the GE portfolio and would be better served under different ownership. Moreover, as GE Capital's earnings become a much smaller part of the whole company, the conglomerate's stock can practically fall into the asset-class group of late-cycle industrials still at market troughs in key businesses. In such a situation, the market could move away from a sum-of-the-parts view of the company and toward an all-in multiple, in line with multi-industry peers.
GE bears will point to possible dilution from the spin off, but the important thing is post this transaction and the continued exits of the real estate equity portfolio, General Electric will have more freedom to re-lever the industrial balance sheet, buy back stock more than the proceeds of the deal, and continue to raise the dividend. As the company de-risks its financial business, it should re-risk its industrial business. Either way, a simpler GE with a higher quality earnings stream will likely be a much more compelling stock.
Nicholas Heymann, a William Blair & Co analyst said in a note "A spin-off of GE's consumer business would be a significant positive for the company, as it would expedite its shift to industrial earnings solidly outgrowing GE Capital."
Valuations and Financials
Compared with its industry, General Electric is trading at very attractive valuations. It has a current P/E ratio of 16.9 compared with the industry average of 18.6. GE has a PEG ratio of 1.6 and a forward P/E of 12.6, compared with 14.8 of the S&P 500.
The company has a price-to-book ratio of 2.0 compared with the industry average of 2.8. It has price-to-sales ratio of 1.7, slightly more than the industry average of 1.6. Finally GE has a price-to-cash flow ratio of 8.6 compared with the industry average of 11.1. The company has a sector-leading dividend yield of 3.1%.
Conclusion and Investment Thesis
We have a buy rating on GE and we view the recent news flow as positive. The company has a strong and high margin services business, good emerging market positioning, and a strong R&D franchise. Moreover, GE's cost-cutting initiatives are on track; the company is aggressively cutting costs and has sliced expenses by more than $474 million by the end of 2Q13. With the potential for low-cost borrowing and a high dividend yield, buybacks are highly accretive, not just to EPS but also to cash flow and that's why asset sales / spins from GE with outsized share repurchases makes sense. The PLCC exit may be viewed as taking a necessary step back in order to take two steps forward; repositioning the portfolio in a critical way and better aligning the company with shareholder interests.
A GE back to its core roots is a very compelling investment story. Focusing on businesses where it has core competitive advantages - e.g. infrastructure - focusing on being the low-cost supplier, beating margins in a clean way, showing better orders than expected and executing on most initiatives in a far better way than the recent past. Overall GE is moving in the right direction and looking at a healthy 2H13, particularly 4Q13. In the meantime, a sector-high dividend yield of 3.1% pays investors for their patience.