- Divesting the consumer finance segment into a new company not only reduces the credit risk but also allow the company to expand its lending to mid size companies.
- The possible divestiture of GE Money Bank is another step to reducing uncertainty in consumer finance and will allow focusing on its core industrial business.
- With increasing contribution of services in the revenues, the industrial business is set to post higher margins and earnings.
- Given the projected dividend yield of 3.4% and forward P/E of 14, the stock is inexpensively priced compared to the industry.
Stable revenues, cash flows and a projected dividend yield of 3.4 percent are the elements that make General Electric (NYSE:GE) an ideal play within the industry. In addition, by filing for IPO of its North American credit card unit, the company has managed to reduce the financial exposure. Although the industry in which the company has been operating does not offer alluring growth, it will also keep it from getting into trouble. Therefore, in today's market environment, General Electric seems to be a nice conservative investment for the long term. Let's discuss the factors why I believe the company is worth investing in for the long term.
Offloading the Consumer Financing Segment
In an effort to simplify its business approach, General Electric recently filed a statement with SEC for the IPO of its North American retail finance unit. According to estimates, the new unit will be valued at around $20 billion. Upon successful completion, this GE unit will be the largest issuer of private label credit cards in the US. GE will be selling 20 percent of this business while the remaining units will be distributed to the shareholders of the parent company.
The consumer finance business has not been a success for the company. The consumer finance segment once constituted more than half of its earnings but during the financial crises of 2008-09, the segment was badly affected. Consequently, the company was forced to cut its dividend and the stock price fell to a single digit. So divesting the segment evolved as a deliberate strategy to avoid such a scenario in the future.
Moreover, the divestiture of its North American retail finance unit will help General Electric to reduce the size of GE capital. The lower exposure to the financial sector will enable the company to shift closer to its basic industrial business.
In addition, to continue its efforts to reduce credit risks while focusing on its core industrial businesses, the company is currently exploring various options to divest its GE Money Bank unit located in the Nordic region. GE is expected to receive up to $2.75 billion as a result of this divestiture. The divestiture of the Money Bank unit will further allow the company to realign its corporate strategy to a manufacturing based entity.
Industrial Business: the Growth Driver
With the divestiture of its consumer financing segment, the company is set to grow its industrial focused business approach. GE predicts it will increase the earnings contribution of the industrial business up to 70 percent by the end of 2016, reflecting an increase of 15 percent from 2013's earnings contribution of approximately 55 percent.
Source: Company's Annual Report 2013
The higher earnings contribution is expected to be driven by improved margin growth of up to 17 percent in 2016, higher than the 15.7 percent growth in 2013. The improved business model in fact is the prime driver of higher margins and earnings. The point here is that GE's industrial business works more like a traditional "razor and blade" model such as after-sale services when customers purchase hi-tech machineries like jet engines. The company often opts for ongoing service contracts that could go on for years.
GE is determined to make services a major part of their earnings. For the last couple of years, the service segment accounted for 28% of the revenues but due to lower operating costs it constituted almost 40% of the earnings. Moreover the services segment makes up 74% of the current backlog of $244 billion. The services segment ensures long-term income stream coupled with comparatively lower operating costs. The change of sales mix between services and products will be margins and earnings for the longer term.
General Electric is offloading its retail finance segment but intends to continue allowing its finance business to lend to mid-size companies, vehicles aviation and energy. Going forward, with the divestiture, the company expects a drop of $7 billion in 2014 and $5 billion in 2015. However, the cash generated from the deal will help it to increase its earnings mix from its industrial manufacturing business to up to 70% by 2016.
Currently, the company offers a dividend yield of 3.40% that represents a dividend of 0.88 per share with a payout ratio of approximately 59.80 percent. Moreover, it has been trading at a cheap forward P/E of 14. The comparatively higher dividend yield highlights the attractive investment opportunity for investors who want a quality income stream. Therefore, I recommend buying the stock.