General Electric (NYSE:GE) recently released its 2016 10-K so I wanted to spend some time discussing the metrics that I first covered in "GE: The 2 Key Metrics To Monitor in 2016" (published in December 2015). In that article, I explained why it would be important for investors to monitor GE's debt balance and payout ratio while the storied company transitions from a misunderstood conglomerate to a more industrial-focused company.
Within this article, I will review these two metrics for full-year 2016 in order to determine how well GE's management team was able to re-position the company over the last four quarters.
The Debt Balance: Where Does The Company Stand?
GE's financing arm, GE Capital, used to account for ~50% of the company's earnings and this resulted in the market viewing (and valuing) the industrial conglomerate more like a financial institution so Mr. Jeffrey Immelt, GE Chairman & CEO, made the game-changing decision to sell off a majority of the financing assets in order to return the company to its industrial roots. The plan was dubbed "A simpler, more valuable GE".
Financing operations are a highly leveraged business so GE consistently had an oversized debt balance, which increased the company's risk profile. Therefore, I have been monitoring GE's debt balance since mid-2015 in order to stay abreast of how well the management team has been able to de-risk the company's balance sheet.
Below is an excerpt of the Statement of Financial Position that was taken from the 2016 10-K. The line items that I will focus on within this article are highlighted in red.
The table below was created with data from the 2016 and 2015 10-Ks, and the balances are broken out between GE (all affiliated companies except GE Capital) and GE Capital.
(Sources: 2016 10-K and 2015 10-K; table created by W.G. Investment Research LLC)
* - Total debt balance in the table only represents the company's short-term and long-term borrowings for the respective period-ends. See linked reports for additional liabilities (e.g. accounts payable, dividends payable, etc.)
The biggest takeaway from the table, in my opinion, is that GE's consolidated debt balance is down by ~$185b, or ~50%, since 2014. Yes, industrial GE currently has a higher debt balance ($16b in 2014 vs $79b in 2016) but this is a necessary evil that management will have to contend with as the company continues to shift its focus more towards the industrial businesses and the financing Verticals. Another important takeaway is the fact that GE Capital still makes up ~60% of the consolidated debt balance so, in my mind, there is an opportunity to further reduce the company's leverage as the financing assets are sold over the next two plus years.
The trending of GE's consolidated debt balance shows that management has made significant progress in reducing the company's financial leverage in a short period of time, but I do believe that more work needs to be done. As a long-term investor, it is encouraging to see GE's focus shift more towards its industrial business because a purer play industrial company will eventually warrant a richer valuation once the market is sold on the company's transition.
Before I touch on GE's payout ratio, I wanted to first show the progress that has been made to reduce the company's share count.
GE's share count has declined by over 1b shares, or over 10%, in three short years. The company has had to sell off financing assets to fund some of the buybacks but the management team has already been able to make up for the lost earnings.
(Full Disclosure: the 2015 earnings were impacted by the "one-time" charges related to the GE Capital asset sales)
Therefore, not only is GE's share count down significantly since 2014 but the company has also already been able to replace most of the lost earnings and the earnings are now largely coming from the industrial businesses.
GE maintain a $0.23 quarterly dividend throughout 2016 so the company paid out ~60% of its operating earnings. Management increased the quarterly dividend by $0.01, or 4%, in December 2016 so the company is projected to also have an ~60% payout ratio in 2017 (based on the low-end of the forward operating earnings estimate). Mr. Immelt and company wants GE's payout ratio to be between 45-50% so investors should start to bake in the fact that the company's dividend will likely only slowly grow through 2018. However, looking out past 2018, I believe that the shrinking share count will allow for GE to jump back into dividend growth mode, especially if the restructuring is complete.
The management team is making great progress in reducing GE's debt balance and share count, but investors should not expect for substantial dividend raises anytime soon. In addition, many people in the financial community, including myself, believe that GE will soon be taking on more debt (read about this topic here) but I still do not believe that the company's financial leverage should be viewed as a significant concern, at least not yet.
GE shares are trading at what is widely viewed as a "fair" valuation, but, in my opinion, this company has the potential to greatly improve earnings over the next decade. Management already re-affirmed the 2018 EPS estimate of $2.00 plus, so based on this estimate GE shares still have room to run. Moreover, GE currently pays an above-average dividend and the company has several significant catalysts in place - Alstom integration, Baker Hughes (BHI) merger, Industrial Internet Of Things (IIoT) growth - that have the potential to create a great deal of shareholder value in the years ahead. As such, any significant dips in GE's stock price should be viewed as long-term buying opportunities.
Note: I will be diving deeper into GE's 2016 10-K over the next few weeks so please let me know if you have a topic that you would like covered.
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Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
Disclosure: I am/we are long GE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.