By Ahmed Ishtiaq
General Electric (GE) issued new debt worth $7 billion during the past week. This was the first debt offering by the company since November 2007, when GE raised $4 billion by issuing 5.25% bonds maturing in 2017. With the current low interest rate environment, companies are raising funds from debt markets and getting exceptionally low rates. While some investors might feel having more debt is bad, it all depends on the debt structure of the company.
Companies issuing debt may utilize this for two purposes; to pay off higher-interest debt or to reinvest in a business that is generating higher capital. Let's look at how GE can utilize this new debt, and what could be the rational to borrow. First, I will talk briefly about the details of the three instruments issued by the company.
New debt Issues:
GE issued three new bonds worth $7 billion. The three-year debt yields 0.859%, 10-year bonds yield 2.727%, and the 30-year bond offers a yield of 4.158%. These are exceptionally low rates for the firm, but they are slightly higher than the current U.S. treasury debt yields. General Electric gains by using these low rates. It has traditionally been quite proficient at being opportunistic when rates are low. The new bonds are rated Aa3 by Moody's Investors Service, fourth-highest level, and two steps higher at AA+ by Standard & Poor's.
What can be the uses?
The first use that comes to mind is the replacement of the old high-yield debt. GE owes $5 billion worth of previous debt offering maturing in 2013. It is believed that the company will use the proceeds from the current issues to pay that $5 billion, 5% debt issue maturing in a year. GE reported massive cash reserves in its previous earnings announcement, and one may ask why the company has not used its cash reserves to pay debt. However, in the current low interest rate environment, it makes perfect sense to raid the debt market and refinance the debt at lower rates. Other than that, the borrowings can also be used to pay dividends, which I believe is less likely as the company had a remarkable year. At present, GE shares yield about 2.96%.
How does it affect the debt situation?
In a previous article, I analyzed the cash flows and debt of the company based on some essential metrics. As a result of this new debt, there will be some positive changes in those metrics. If, the company replaces its old debt with new debt, the interest expense will come down for GE. As a result, interest coverage ratio for GE will increase and further strengthen the position of the company. In addition, the total debt service ratio will be impacted positively. GE has had an extraordinary 2012, and the company is expected to report improved free cash flows than the previous year. I also expect the company to report improved FFO, which will further strengthen the FFO to total debt ratio of the company.
GE will report its earnings on Friday, October 19, and the company is expected to report impressive operating results for the quarter. Recently, GE has been focusing on its core industrial business, and the company has been selling non-industrial assets. As a result, GE has been able to achieve operational efficiency and cost savings. At the moment, the international economy is growing at a slower rate than expected and forcing GE to enhance profits by cost savings. GE said at an investors meeting in September that the company will have $100 billion in cash between 2012 and 2016, but the company will only look at fairly small acquisitions. GE will use $15 billion to buy its own shares to reduce the number of shares outstanding. For the third quarter, analysts anticipate earnings of 36 cents per share on sales of $36.95 billion. My expectation is more or less is in line with the analysts. GE will also recognize gain from its fractional ownership of NBC, offset by restructuring costs and other charges.
In our previous analysis, we have established that GE should be able to maintain its current dividends. However, the recent moves by the company in debt markets lead me to believe that the company is confident about the growth. Borrowing at a low rate will help the company bring down its interest expense and leave more cash for dividend payments. I believe GE will increase its current level of dividends soon. In addition, a positive earnings announcement should give stock price a push upwards. GE stock has gone up by almost 38% over the last 12 months. Strength of its operations along with future prospects in emerging markets played a vital role in the increase in stock price. I expect the stock to be an outperformer. Particularly, I expect growth in dividends along with attractive capital returns for long-term investors.
Disclaimer: EfsInvestment is a team of analysts. This article was written by Ishtiaq Ahmed, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.