GE Does Not Bring Good Things For Your Life
When is a stock safe enough to buy when it becomes difficult for corporations to find financing? We can answer the question two ways: 1) Why should we buy stocks when the financial markets are choking? Better to sit on cash. 2) We can’t tell when the turn is coming, so if we buy companies that are cheap with strong balance sheets and free cash flow, we should do okay over the intermediate-to-long run.
I’m going to illustrate this with a single stock tonight: General Electric. Why GE? Here’s something I haven’t mentioned recently about how I source stock ideas. I read widely, and when some one tells me a stock is cheap, I write it down for later analysis. My initial cursory analysis during this time of credit stress looks like this:
Let’s look at earnings estimates:
Yeah, is does look cheap. How has it done recently relative to expectations?
Mmmm…. not so good. Looks like they are still working off all of the bad accruals from the Jack Welch era.
Now, let’s look at the balance sheet:
Mmmm… there are a lot of intangibles on the balance sheet. Taqngible book value is light. Perhaps the intangibles have real economic value. If so, I would expect to see additional earnings over operating cash flow, and the is not there. Let’s look at debt maturities, could there be a call on cash?
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That doesn’t look good. What if we look at only the holding company?
Okay, not so bad. Most of the debt is from the finance subsidiary that I have argued for years should spun off. In a pinch, what are the odds that they would send GE Capital into insolvency? Very low, so I worry about the refinance risk. Will GE Capital get attractive financing terms over the next several years?
On to cash flows. Here are the cash flow screens:
Okay, free cash flow is positive, and congruent with earnings over the last five years. That’s a good sign. What else is there to look at?
holding-company-only.gif
Okay, Price-to-sales indicates that GE could be cheap versus their long history, but it could get cheaper.
Let’s look at summary statistics:
From all of the above, as I look at GE, there is a refinancing problem. Many debts come due over the next 5-10 years, probably matched by debt repaqyments over the same horizon. The effect of default from these repayments could be significant. I doubt that GE would be willing to send its finance subsidiary into insolvency.
In conclusion, even at the low levels that GE stock price has reached, I’m not comfortable with it. GE will have to refinance a lot of its debt over the next five years, unless they sell or default on GE Capital. The debt load outweighs the seeming cheapness.
Full disclosure: no position
November 19th, 20083:25 pm at
Did you notice that there is strong seasonality in the earnings that broke in 2002 and now in 2008? I never noticed it before. I can’t imagine which part of the business is seasonal, but it’s there.
My father, who has never owned equity in anything during his lifetime (home or otherwise), recently called me up and asked what I think about GE. I told him that it has a nice dividend and ostensibly cheap valuation ratios, but I am terrified of the black box known as GE Capital. In the best of times, it makes GE beat by a penny; in the worst of times…
I told him to pass on GE and I don’t feel so crazy for it now that you posted all of this.
November 19th, 20084:16 pm at
o/t
FYI: David, whenever you put charts or images into your webpage, there is a huge gap of white space between the text and the first image. So you have to page down many times before you actually see the image. I use IE – not sure if it happens on other browsers.
November 19th, 20089:52 pm at
This analysis is very instructive – thanks.
November 20th, 20084:16 am at
very helpful. many thanks
November 20th, 20086:22 pm at
Those Bloomberg screens are fancy. I particularly like the balance sheet and cash flow from CH!
November 20th, 20087:39 pm at
With so many stocks down, wouldn’t it be simpler to focus on companies holding net cash on their balance sheets? E.g., CSCO, XOM, etc. Why even bother with debt-laden companies if you don’t have to?