For investors looking for a large-cap company that is refocusing its business, General Electric (NYSE:GE) is a dividend paying company that is "trimming the fat" to create room for future growth.
On March 4, 2009 at 1:40 pm, General Electric's shares touched a low of $5.73. This was in part due to the financial arm of the company and the massive amount of debt accrued in the previous years. The total liabilities climaxed in 2008, when General Electric reported total liabilities of $708.83 billion. It was ultimately the shareholders who paid for it in 2009 with a punished stock price and dividend cut.
Since the lows of 2009, for the survival of the company management was forced to reduce this aspect of the company and refocus how the company was going to move looking forward.
Using the analysis below, I will analyze the past five years of General Electric's debt reduction. I will look at ratios including total debt to total assets, debt to equity, interest coverage and cash flow to debt. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how management has fared over the past few years and will give us an idea of how safe the investment is or would be moving forward.
1. Total Debt = Long-Term Debt + Short-Term Debt
A debt is an amount of money borrowed by one party from another, and must be paid back. Total debt is the addition of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt that is due within one year. The combination of the two is total debt.
- 2009 - $338.215 billion + $133.054 million = $471.269 billion
- 2010 - $323.383 billion + $107.750 million = $431.113 billion
- 2011 - $272.717 billion + $137.611 million = $410.328 billion
- 2012 - $236.084 billion + $131.515 million = $367.599 billion
- 2013 TTM - $226.872 billion + $161.223 billion = $388.095 billion
Since 2009, GE's total debt has decreased from $471.269 billion in 2009 to $388.095 billion in 2013 TTM, a decrease of 17.64%.
2. Total Liabilities
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total Liabilities are the addition of long-term liabilities, which are the liabilities that are due in one year or more, and short-term, or current liabilities, are any liabilities due within one year. The combination of the two equals the total liabilities.
- 2009 - $664.527 billion
- 2010 - $632.280 billion
- 2011 - $600.804 billion
- 2012 - $562.302 billion
- 2013 TTM - $538.746 billion
GE's liabilities have decreased from $664.527 billion in 2009 to $538.746 billion in 2013 TTM, a decrease of 18.92%.
3. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2011 - $410.328 billion / $717.242 billion = .57
- 2012 - $367.599 billion / $685.328 billion = .54
- 2013 TTM - $388.095 billion / $660.541 billion = .59
Currently, General Electric has a total debt to total assets ratio of .59. The total debt to total assets ratio has increased over the past three years. The company has increased this ratio from .57 in 2011 to .59 in 2013 TTM. As the total debt to total assets ratio has increased, this indicates a slight increase in financial risk to the company.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is highly leveraged could be in danger if creditors start to demand repayment of debt.
- 2011 - $600.804 billion / $717.242 billion = .84
- 2012 - $562.302 billion / $685.328 billion = .82
- 2013 TTM - $538.746 billion / $660.541 billion = .82
In looking at General Electric's total liabilities to total assets ratio over the past three years, we can see that this ratio has also decreased slightly. The ratio has decreased from .84 in 2011 to .82 in 2013 TTM. Because the ratio is well above .5 this indicates that GE is still in danger of being highly leveraged.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2011 - $600.804 billion / $116.438 billion = 5.16
- 2012 - $562.302 billion / $123.026 billion = 4.57
- 2013 TTM - $538.746 billion / $122.692 billion = 4.37
Compared with 2011, General Electric's debt-to-equity ratio has decreased. The ratio has decreased from 5.16 to 4.37. As the ratio is currently well above 1, this indicates that suppliers, lenders, creditors and obligators have more invested than shareholders. 4.37 indicates a large amount of risk for the company and the shareholder.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2011 - $272.717 billion / $389.155 billion = .70
- 2012 - $236.084 billion / $359.110 billion = .66
- 2013 TTM - $226.872 billion / $349.564 billion = .65
Over the past three years, General Electric's capitalization ratio has decreased from .70 to .65. As these ratios are declining, financially this implies a declining amount of risk for the company.
7. Interest Coverage Ratio = EBIT (Earnings before interest and taxes) / Interest Expenses
The interest coverage ratio is used to determine how easily a company can pay interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense, the higher the ratio the better. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable.
- 2011 - $34.643 billion / $14.545 billion = 2.38
- 2012 - $29.914 billion / $12.508 billion = 2.39
- 2013 TTM - $27.411 billion / $10.687 billion = 2.56
As the interest coverage ratio is in the mid 2s this indicates that GE is able to cover its interest payments.
8. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2011 - $33.359 million / $410.328 billion = .08
- 2012 - $31.331 million / $367.599 billion = .09
- 2013 TTM - $28.415 billion / $388.095 billion = .07
GE's Cash Flow to Total Debt ratio is very low. As the current cash flow to debt ratio is well below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations. GE is still vulnerable if the economy were to have another significant decline.
Since the recession GE has focused on its debt reduction. As the analysis above states, Jeff Immelt is doing a good job of debt reduction, but the analysis also reveals the company is not secure yet. A cash flow to total debt ratio of .07 is still very weak. A total debt ratio of .82 displays that GE still has almost as many liabilities as assets thus indicating significant risk to the shareholder. Even though GE is reducing its debt, the company still holds a significant amount risk to the shareholder.
Price to Liabilities
As the chart above indicates, the price of GE's stock corresponds conversely with GE's total liabilities. As long as GE's management continues its refocus plan and continues to clean up the balance sheet, I believe this price action will continue.
Moving forward, I believe the company is doing many positive things to continue reducing its total debt and liabilities. The company's plan to focus on its industrial roots should streamline center it on an industry poised for growth.
As GE is focused on getting back to its industrial roots the spin off of its credit card business next year into a separately traded company will reduce its exposure to the unpredictable financial businesses.
According to Reuters, the new company is expected to be worth $16 to $18 billion and would be equal to about 6 percent of GE's overall market value.
As GE is focusing on its industrial roots there are many opportunities for growth within this sector. Currently, the railroad industry is exploring the idea of switching from Diesel fuel to LNG. If the industry does make the transition this will be a huge catalyst for GE.
Currently, GE is working with Berkshire Hathaway Inc.'s (NYSE:BRK.A) Burlington Northern Santa Fe LLC, Union Pacific Corp. (NYSE:UNP), Norfolk Southern Corp. (NYSE:NSC) and CSX Corp. (NYSE:CSX) to reduce emissions and increase profitability in the railroad industry.
To aid in this transition GE offers retrofit kits enable existing Evolution Series locomotives to operate on both diesel and LNG. These kits are designed to substitute up to 80% of diesel fuel with LNG. Even with the two sources, GE states its use can reduce fuel costs by 50% without diminishing their performance. These retrofit models currently meet US EPA Tier 3 emission standards and also allows a fully-loaded train to travel further distances without refueling stops, thus increasing profitability for the railroad companies.
Something To Keep An Eye On
On December 13th, Bloomberg published an article stating that "GE's mergers-and-acquisitions plans will be the most important topic" at the annual winter meeting on Dec. 18th. The focus of the mergers-and-acquisitions will be to help replace revenue lost from the impending spin-off.
GE has increased their exposure to the Energy markets with the acquisitions of Dresser Inc. in which they spent $3 billion, Wellstream for $1.2 billion and Lufkin Industries which they spent $3.3 billion; these look to be positive moves for the company. Another company in the Oil and Gas service industry that GE is rumored to be interested in is Dril-Quip Inc. (NYSE:DRQ).
As the ratios and charts above indicate, the company's stock price corresponds conversely to the amount of debt and liabilities the company has incurred. If management overpays or the market does not agree with the purchase, I believe the shareholder could ultimately pay for the mistake again.
Currently, I am bullish on the outlook of GE in 2014, as long as the company continues on its overall plan to reduce its debt and strengthen its balance sheet. I believe the spin-off will help mitigate their exposure to the instability of the financial markets thus creating some stability for the shareholder. Having stated that as GE looks to be focusing on M&A in the new year, this is something to keep a close "eye on." If the liabilities begin to increase or the company overpays for an asset, I believe the shareholder could ultimately be punished with a large fall in the stock price. As the analysis above indicates, if GE begins to increase their debt and liabilities, I believe the stock price will begin to decline thus constituting a sell signal for the investor.