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?
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?
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