General Electric Company (NYSE:GE) for a long time has been dependent on its financial services business that was severely affected by 2008/09 crisis. The company has been reducing its exposure to this sector since then and now focuses on its core infrastructure and healthcare business. Even though net income has been volatile in the last two years, this didn't harm dividend payments so the stock can be a potential buy for stable income seekers.
Historically known as an industrial company, GE for a prolonged period was highly dependent on its financial subsidiary, GE Capital [GEC]. In FY2008 a solid 36.7% of total revenues were derived from GEC. Moreover, the elevated leverage was also more common for a financial company than for a manufacturing one - as evidenced by the consolidated "Debt to Equity" ratio of 5.0x at end-FY2008. In the course of the 2008/09 crisis, GEC's solvency and liquidity slumped, and it required substantial governmental aid. To do so, the Federal Deposit Insurance Agency agreed to guarantee $139bn of GE Capital's debt imposing restrictions on dividends at the same time. As a result, GE in its entirety had to cut dividend payouts and stock prices reacted accordingly - GE shares underperformed both the S&P 500 and DJIA indices (fell by 54% in FY2008 while the S&P 500 declined by 37% only). After that reduction in financial services share in earnings was anticipated.
The other problem for GE is declining profitability of its traditional products - heavy machinery and power equipment. Even though for 9m2016 total revenues grew by 8.5% YoY, operating profits declined by 2.3%. The reason was the outrunning growth in cost of sales of tangible products as indicated by a decline in operating margin from 19.3% to 16.6%.
The company now tries to overcome these negative effects by [i] decreasing its exposure to the financial sector, [ii] focusing on core infrastructure and healthcare markets, and [iii] introducing services with higher added value. It has achieved apparent progress in these areas.
First of all, the "GE Capital Exit Plan" that was declared in 2015 is almost completed by now. GEC's assets shrunk and long-term borrowings fell below $100bn at end-3Q2016. As a result, the share of GE's financial business dropped to just 9.1% of consolidated revenues and the leverage decreased to 2.3x. The stock volatility also declined - for the last 12 months the maximum drawdown was at modest 16.6%.
GE is trying to substitute the lost revenues through M&A activity. The most significant purchase recently was the acquisition of Alstom's renewable energy-related businesses for $10.1bn. It contributed significantly to GE's backlog so at end-3Q2016 it amounted to $319.2bn. These are contracts with customers that are signed but not yet fulfilled - eventually, the backlog is a proxy for future revenues. Another significant undertaking is an agreement with Baker Hughes to create a partnership operating in oil & gas segment. GE will have a controlling interest in this party and even though the immediate effect will be a decrease in revenues GE itself expects $1.6bn per year synergy effect mostly through cost saving by 2020.
The company is at the same time simplifying its structure by selling non-core businesses. In 2016 it completed the divestiture of GE Asset Management ($100bn of assets under management) and Appliances business. Also, Aviation business line is classified as held for sale which indicates that it's most likely to be sold within the next 12 months.
Last but not least, to provide more marginal services GE has declared a transformation into what it calls a "Digital Industrial Company". Effectively its intention is to process the data received from physical assets and give recommendations to the clients on how to operate the equipment more effectively. These efforts are fruitful already - as a result of increasing profitability the margin on services has increased from 26.5% to 28.8% in 9m2016 YoY.
Although all the above-mentioned activities are quite costly (e.g. GE will contribute $7.4bn in cash dividends to Baker Hughes shareholders in the process of creating the new partnership) the company has a significant stockpile of liquidity to withstand it (13.5% at end-3Q2016).
From the stable income perspective, the good point is that GE's dividend payouts are not dependent on earning volatility - at least for now. In 9m2016 net earnings were positive as opposed to 9m2015 ($4.7bn vs -$12.4bn). Even with such volatility dividends per share were stable at $0.23 per quarter since 2015. Currently, dividend yield is about 3.2% and the company has sufficient capacity to support it. It should be taken into account though that due to still elevated exposure to financial sector the beta of the stock is above average (1.10) so GE is more volatile than, for instance, United Technologies Corporation (UTX), one of its key competitors (beta 1.04). So GE stock could become a valuable addition to a portfolio with medium- or long-term investment horizon while it can exhibit some volatility over the short term.
