General Electric (GE) has learned valuable lessons from the financial meltdown of 2008 - the company has now turned focus towards its core business and diversification. On January 6, 2014, the company agreed for the acquisition of some assets related to life-science of Thermo Fisher Scientific, which would cost the company $1.06 billion. For the past few quarters, GE was showing in upward trend but as of now the stock is going down after hitting a 52-week high of $28. There has been a lot of talk these days about how the interest rates are about to rise. This might be the time for General Electric to makes some gains out of this situation.
Economy Following "Quantitative Easing"
Quantitative easing is a plan that government implemented to boost the economy roughly around six months ago. The desired results of the plan were to increase the growth of the economy and decrease unemployment while keeping the interest rate down. Now that things are looking good with respect to the economy, the government would want to increase interest rates soon. This would eventually affect all industries but financial sectors the most. General Electric Capital has six sub-business units which include consumer financing, commercial lending and leasing, real estate financing, Energy financial services, GE Capital aviation services, and corporate financing.
Looking at the financials of the third quarter, the company made revenues of $10.6 billion as opposed to last year revenue in the third quarter of $11.2 billion. That shows a decrease of 5%. The operating expenses, however, decreased by 7% from $9.5 billion to $8.8 billion. This 2% difference adds to the company's efficiency. Furthermore, the provisions for income tax decreased from $80 million to $1 million, loss of discontinued operations also decreased by $20 million giving the company a far better net profit margin. This is how the company increased its net income despite the falling revenues which is a very good indicator of the company's improving efficiency. As the quantitative easing process is at its end, it is likely that the Federal Reserve will increase interest rates, which will enhance the revenues of General Electric Capital.
Valuation For GE Capital
The amount of long-term debt is huge, it does not outweigh its total tangible assets. If we take the total assets of $520.7 billion and subtract goodwill and other tangible assets of $26.7 billion and $1.2 billion, respectively, the total tangible assets become $492.8. Further subtracting the total liabilities of $436 billion, total tangible book value of the company becomes $56.8 billion. Further, if we divide this value by the number of outstanding shares, the tangible book value per share becomes $5.61. While GE has other business units, this value only shows how much GE Capital accounts for in the stock of the whole company.
This is quite understandable as the company has been trying to take its focus from its Capital unit to its Power Unit. The Power unit has interesting growth opportunities for GE as the demand for LNG increases around the world. Most recently the company won a $65.4 million pentagon defense contract. This contract is scheduled to end by December 2014.
As I mentioned in the introduction, the company is focusing on its core business and making GE Capital more efficient. In the previous article, I talked about the trend in revenue and income from GE Capital and how the overall contribution from this segment has been managed by the company. At the moment, we are seeing the operations of the company become efficient, resulting in higher margins. Furthermore, the upward trend in interest rates will further enhance the income from GE Capital. However, the actual effect of increasing interest rates cannot be measured until we know the nature of each long-term debt. Nonetheless, GE will certainly benefit from the rising interest rates in the future and offer substantial value to shareholders. Cash flows of the company will also be impacted positively by the increase in interest rates.
Despite the solid price growth, I think GE still has substantial upside potential. As far as the recent price drop is concerned, it looks like investors are booking their profits. The forward P/E of the stock is 17.1 and the long-term earnings growth rate of 8.9%. For a company of the size of General Electric, it is an extremely impressive growth rate in earnings.