GE - General Electric

[tiddman]

I was interested to hear that Berkowitz has taken a position in GE, I have actually been looking at it myself.

 

Not much needs to be said about GE's core businesses.  They are generally all solid manufacturing businesses and generate above-average returns on both equity and invested capital, and they tend to be in the top 2 or 3 in each of their markets.  I particularly like some of the business units in terms of margins and growth prospects, such as their energy and infrastructure lines.  GE doesn't have the magic it had when Jack Welch was in charge, but much of his wisdom is institutionalized in the corporate culture.

 

However, GE got into trouble in the credit crisis, for two reasons I believe, 1) they are wholly dependent upon the credit markets for liquidity, routinely rolling over $50+ billion in debt and commercial paper per year, and 2) their finance units grew to be as large as the rest of the company and got into trouble along with most other banks.

 

Until I looked, I didn't realize how much debt they carry.  Overall debt/equity is around 2:1, that's book value of around $175 billion, and about $335 billion in debt.  Most of the debt is at GE Capital, which reports about $500 billion (!) of debt + deposits.

 

This makes Buffett's $3 billion preferred investment look like a drop in the bucket.  GE Capital runs a debt:equity of about 6, I haven't looked at the details but I assume that Buffett's investment was injected into GE Capital to support ~$15-18 billion of financing as a stop gap when GE had liquidity problems in late 2008 when the commercial paper markets froze.  GE is completely dependent upon the commercial paper and debt markets for liquidity.

 

At the end of 2007 when the fit was just hitting the shan, GE carried only $16B in cash + equivalents (including I'm guessing a lot of "equivalents" that didn't turn out to be so equivalent). Given the size of their operations, I guess a liquidity problem wasn't too hard to predict (in retrospect of course).  Since the Buffett investment, they've gone into liquidity-lockdown mode, have cut the dividends, decreased originations in their lending units, got a bunch of bailout money, sold off some assets, etc. and cash + equiv. are now up to $78 billion, which I'm guessing is by far the most cash the company has ever carried.  I guess that's what happens when Uncle Buffett takes an equity interest in you.  Predictably, ROE is now around 10%, down from the 18-20% that GE ran in the heyday, and they are if anything overcapitalized.

 

Today, revenues and earnings almost across the board are down due to the weak global economy.  The stock is under the stigma of government bailout (they participated in the TALF and TLGP programs).  Investors are also discouraged by the decreased dividends.  Returns on equity are at record lows due to the retention of cash, and financing is more expensive than in the past due to losing their AAA rating and some expensive financing they had to get during the crisis, including the 10% rate they're paying Buffett on his preferreds.

 

However, all of these trends seem likely to reverse in the relatively near term (1-3 years).  The global economies are stabilizing and it is probably safe to assume that GE is still an above-average business in most of its markets.  They will gradually wean themselves off of government assistance, which should have a positive affect on the stock (look at GM).  After a couple of years of de-levering, they should be able to reverse this trend and carefully lever back up, which will allow them to deploy their excess liquidity and increase returns on equity.  More than many other companies, they stand to benefit from rock-bottom interest rates as they rolls over their debt.  

 

Going forward, they are talking about backing away from financial services, which at one time generated half of their earnings, and to get back to their bread-and-butter manufacturing businesses.  This sounds like a good idea to me since they probably got too far into the financial businesses during the heyday.   So as things turn around, could GE be a way to play a broad economic recovery?  The stock is trading at around 10x cash flows and the same valuation as it had in 1997.

[ExpectedValue]

My gripe with GE is that they've always been a bit sketchy with their accounting.

 

I think a year back, they were fined by the SEC for using acquisitions to juice quarterly EPS.

 

Plus, during the financial crisis, if they had been forced to mark their loans they would have been in dire straits. I think the thing that saved them was the fact that as a conglomerate, they were able to apply cash flow accounting principles to their problem loans rather than M2M.

 

The other thing I worry about is the fact that they're going to face some stiff competition to do deals going forward. Especially when they are competing with Chinese firms that are backed by the state, this is particularly true in some of the alternative energy areas.

[tiddman]

I have the same concerns about their accounting.  It was an open secret that the company "managed" earnings under Welch's regime, and I seem to remember he even mentioned it in his book.  The issue with the recent SEC investigation wasn't so much accounting issues, as outright fraud -- for instance managers of the business unit booked locomotives as sold before they were, pulling profit into a quarter.

 

I do think that the SEC investigation and subsequent penalty probably had a positive impact on GE, and one thing they stopped doing is giving specific EPS targets every quarter, which is one of the drivers for "reaching" for earnings in a period.

 

At the end of the day though, these mis-deeds are not a big deal over the long term, a few $100 million in profit over a couple of years isn't very material, and moving earnings from one quarter to another becomes meaningless with a long term view.  Investors probably can't assume that reported numbers are 100% accurate, so there could be come loss of trust, but not enough to undermine the overall quality of the business IMHO.

 

The other thing I worry about is the fact that they're going to face some stiff competition to do deals going forward. Especially when they are competing with Chinese firms that are backed by the state, this is particularly true in some of the alternative energy areas.

 

In what industries do you mean?

[Myth465]

Seems like a tough way to make a buck (buying a mammoth like GE). As far as the industries I believe he is referring to Wind turbines and the like. China has an advantage because the government is picking winners and backing them, while we are letting ours twist in the wind.

 

[tiddman]

Seems like a tough way to make a buck (buying a mammoth like GE)

 

Well what is the downside then -- what are the odds that GE stock will be where it is or lower in say 5 years?

[rogermunibond]

WInd turbines and locomotive engines are 2 that come to mind.  CFM, the GE/Safran jet engine JV, landed a big contract with COMAC for the new Chinese made jetliner - so that area is safe for now.

[frog03]

The global economies are stabilizing

 

I am really not sure about this one.  Remove the stimulus and clearly the economies are far from stabilizing.  In Europe alone, we have seen already three countries essentially bailed out (Iceland, Greece, Ireland).  Portugal and Spain may be next.  Bailing Spain or Italy out certainly is not going to be any picnic...

 

Obama is spending like it is going out of style, Michigan, California and several other large states are essentially bankrupt.

 

Maybe I have been following Sprott too long but a combination of declining government spending, increased taxes, and deleveraging does not augure too well for a statement like you are making.

 

Regarding Berkowitz, he has a great track record but his heavy bet on financials (this is really what GE is after all) may or may not pay off.

[tiddman]

Remove the stimulus and clearly the economies are far from stabilizing

...

Obama is spending like it is going out of style

 

Guess these two statements go hand in hand... damned if you do, and damned if you don't.

[Uccmal]

GE still has alot going for it.  There is the non-capital business such as:

Medical Systems - long term sales and servicing agreements - quality and service are paramount

Power Systems - turbines etc.  - huge business

Motors

Alt Energy - mentioned above

Water treatment - relatively new and growing

Military related

 

In Capital there are a number of business that are not directly connected to mortgages Commercial or otherwise:

Fleet Services - Worlds largest auto fleet - leasing

Modular trailers

Credit companies - i.e. they own the receivables for the Hudson's Bay Company in Canada

 

One of the big ones operates at the interface between Capital and industrial - they finance their own customers to buy industrial products.  When done well this works well.     

 

 

[Uccmal]

GE has people installed at high levels in at least the US and Canada partly due to their military and nuclear history.  They are among the first to know about major government contracts and likely have some influence over projects right through the process from inception to execution. 

 

The US government is no less likely to support GE and its ilk, than China is supporting its own home grown industries. 

 

I used to work at GE and got a feel for the organization dynamics and the tight connections with Government.  Kind of like the Goldman Sachs of Engineering and Industry.

 

I hold Ge via 2012 Leaps and am now switching over to 2013 leaps - $17.50s.  I am taking a small haircut on the rollover to the longer term Leaps at the moment.  Earlier on I did very well on 201011 Leaps bought in February 2009.

[Uccmal]

Under Welch, every Quarter GE smoothed the earnings by moving (buying/selling) assets between GEC and off shore and/or off balance sheet entities.  I dont have much respect for Jack Welch.  The early Jack Welch was okay but later on he got too much hubris and arrogance.  The company has had 11 years of recovery from the Welch years.  I think they are finally getting their groove back. 

 

If GM can come back from the dead then I am fairly confident that GE can rebound from mediocrity enough to at least double my investment on the Leaps.

[Myth465]

How has he managed to retain such a great reputation?

[rogermunibond]

Largely via hagiography.

 

He sold his name to for-profit Chancellor University. 

 

http://www.jwmi.com/

[twacowfca]

Largely via hagiography.

 

He sold his name to for-profit Chancellor University. 

 

http://www.jwmi.com/

 

Hagiography! That's a good one!  ;D

[Guest dealraker]

"GE doesn't have the magic it had when Jack Welch was in charge, but much of his wisdom is institutionalized in the corporate culture."

 

Given the insight on this board that comment to me is probably the comment I would have never expected to see.

[jeffmori7]

Is there anyone still invested in GE? Uccmal, did you keep your LEAP position?

 

I bought the common during the financial crisis in 2009, but now, I'm not really confident about the future growth. I think it's a pretty stable core holding, with a nice dividend. We can expect more buyback and a dividend increase in the future, particularly with the financial division starting to repay a large dividend.

 

GE tend to dominate the markets in which it is present, but with a company of this size, what is the growth we can expect in the future?

 

Any thoughts about this one, which seems fairly valued at the moment? It is also the strike price for the Buffett warrants if I remeber well.

[Uccmal]

Hi Jeff, I sold the last of my leaps in August during the run to $21.00.  I needed the cash for AIG warrants where I see much more upside.  The GE Leaps were all 2013s and were losing their time value quickly so I had to be opportunistic and sell on highs. 

 

I think GE will do well going forward but it will be a long slow climb.  I had probably overestimated their speed of growth or return to growth.  I think its fairly valued.  I might buy back in with 2015 Leaps if it pulls back sub 18, or so. 

 

[jeffmori7]

Thanks Al for your answer. It is exactly to increase my position in Aig that I'm considering selling GE.

[berkshiremystery]

Thanks Al for your answer. It is exactly to increase my position in Aig that I'm considering selling GE.

 

There you have some free research page of GE @ ValueLine,... it's from the 30 free DJI stocks.

http://www3.valueline.com/dow30/f3807.pdf

 

 

[jeffmori7]

Yes I have seen that..ValueLine are very bullish on GE with an expected annualized return between 15 to 25% for the next 5 years..

 

It could happen, but you have to believe in these optimistic growth in the sales projection.

[berkshiremystery]

Yes I have seen that..ValueLine are very bullish on GE with an expected annualized return between 15 to 25% for the next 5 years..

 

It could happen, but you have to believe in these optimistic growth in the sales projection.

 

I only look at ValueLine for the past data,... but I never take their estimates serious. If you would look at their BAC reports over the last 2 years, they have gone from euphoria to currently lower estimates. You have to make your own mind.

 

[jay21]

GE was in the news recently with Capital planning a dividend to the parent (  http://online.wsj.com/article/SB10001424127887324102604578494681679014370.html ). 

 

I was just thinking about GE because I thought it may be a good business in terms of selling top quality equipment and leasing it to buyers with a high credit rating.  I was pretty surprised how much GE Capital had in consumer and real estate assets and it turned me off to GE as an investment because they probably don't have a competitive advantage in that area.  I don't think they can compete with banks and their deposits. 

 

Hempton had a decent write-up explaining something similar to what I am explaining ( http://brontecapital.blogspot.com/2008/06/whats-nice-girl-like-you-doing-in-place.html ).  Here he explains the part of GE I was attracted to:

 

"Let’s describe some good equipment finance businesses:

 

    Suppose you have the superior product (say the most fuel efficient jet engine) and

 

    Suppose the product needs regular contracted maintenance or it kills people (such as a jet engine) and

 

    Suppose the product is able to be repossessed and resold and because you have the best distribution system you have the best ability of anyone to repossess it. Besides because of the maintenance schedule you know exactly where it is (like a jet engine).

 

    Finally suppose that the technological obsolescence cycle is say a decade or more so when you repossess it the product is worth something – so you can’t be stuck in the position that Lucent was when it repossessed One-Tel’s mobile phone system. Hey – like a jet engine.

 

Then you have the makings of a truly brilliant finance business. It can make good money almost regardless of the economic cycle of its customers.

 

Notice that this finance business does not even require the airlines to be solvent. It only requires that the product has a technological edge, can be repossessed and does not lose too much value when remarketed. Moreover the best sales network for new product is also probably a good sales system for repossessed product. GE has a competitive advantage in engines (which I think is beyond dispute), is good at selling them and hence has a competitive advantage in financing them.

 

There have been lots of airline insolvencies but the GE finance business skated through unscathed."

 

I can see why Warren and Charlie were attracted to the stock during the crisis because it probably fits into the "cancer" model that Charlie described.  You can cut away a lot of non-core assets because there's a very good business thats worth a lot in there too.

[Uccmal]

The Finance business is a wonderful business.  I like GE better under Immelt than Welch, without the managed earnings. 

 

The also finance infrastructure, wind farms, power plants etc. 

 

Ge capital has the worlds largest fleet of Vehicle leasing.  The only retail driven business left is the appliance and lighting business.  Ge capital also operates in all kinds of strange peripheral businesses. 

 

I recall gong into a GE Capital unit 15 years ago where they were configuring office computers for everyone except Dell and Gateway.  They were assembling IBMs, HPs, Compaqs, and others all side by side in the same room.

 

I no longer hold GE shares but if there is a pullback in the markets it is on the top of the hit list. 

[Guest wellmont]

the finance business would be toast if it was not for US Government bailout, and Buffett bailout. It was insolvent. Buffett likes Immelt. Hates GE Capital, apparently.

[jay21]

the finance business would be toast if it was not for US Government bailout, and Buffett bailout. It was insolvent. Buffett likes Immelt. Hates GE Capital, apparently.

 

I just came across this quote from Munger from 2005's Wesco's meeting notes:

 

 

AIG, GE Credit and the Risks of the Carry Trade

 

That said, it’s a lot like GE. It is a fabulously successful insurance operator, and with success it morphed into a massive carry business: borrowing a lot of money at one price and investing it at another price. AIG was a big operator that was a lot like GE Credit. We never owned either because even the best and wisest people make us nervous in great big credit operations with swollen balance sheets. It just makes me nervous, that many people borrowing so many billions.

 

As you can tell in our operations, we are much more conservative. We borrow less, on more favorable terms. We’re happier with less leverage. They’ve been successful, but we’re too chicken to join them. You could argue that we’ve been wrong, and that it’s cost us a fortune, but that doesn’t bother us. Missing out on some opportunity never bothers us. What’s wrong with someone getting a little richer than you? It’s crazy to

worry about this.

 

There’s a lot of leverage in those carry-trade games. Other people are more certain than I am that aircraft can always be leased.