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I'm taking a closer look at GE, the industrial cum uber bank bellweather of the Fortune 500. See the following draft overview, to be followed up by a full forensic analysis. I apologiz, for I've had this on my desk for a while and forgot to post it and was reminded about it when a sell side analyst downgraded GE this morning.

General Electric (GE)

 

General Electric share price has declined 22% in the last six months

 

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The General Electric share price has taken significant beating in the last six months and has fallen 22% on account of its exposure to the financial services business and currently trades at US$29.05 per share. GE’s share price declined almost 13% on 11 April 2008 as it reported a significantly lower than anticipated 1Q 08 results. The share price has fallen by almost 21% since the announcement of its 1Q 08 results.  

 

 

GE derives majority of revenues from Infrastructure segment and the commercial finance and GE money segment

GE having a diversified business generates majority of its revenues from the Infrastructure segment along with the Commercial Finance and GE Money segments. Infrastructure segment contributes 36% of the revenues, while commercial finance and GE Money contribute 21% and 15% to the revenues. In this tough credit market conditions, the consumer and commercial finance business continue to remain under a lot of strain as witnessed in the last two quarters. In the last few quarters, the growth in infrastructure business is holding the flag high for GE. In 1Q 08, apart from infrastructure and NBC Universal, all the segments reported decline in profitability.

 

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GE has a very well diversified geographic revenues stream, deriving 50% of its revenues from the US and 23% and 13% from Europe and the Pacific basin, respectively. The Americas and Middle East & Africa contribute 7% and 5%, respectively.

 

Geographical revenue breakup

 (In billions) 

2005

2006

2007

 U.S.  

76

81

86

 Europe  

29

33

40

 Pacific Basin  

16

18

22

 Americas  

10

12

13

 Middle East and Africa  

4

6

8

 Other Global  

2

3

4

 Total  

137

152

173

 

GE Capital Services

GE Capital services (GECS) includes the financial services business of GE comprising Commercial Finance, GE Money and the Aviation Financial Services, Energy Financial Services and Transportation Finance included in the GE Infrastructure segment. GECS contributed 42% to the company’s top-line and 46% of the bottom-line of GE.

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GECS contribution to net earnings has increased from US$7.9 billion in FY 2003 to US$10.3 billion in FY 2007.  Commercial Finance and GE Money contributed 34% of net income in 1Q 08, while the Infrastructure segment contributed 42% of the bottom-line.

 

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Infrastructure segment the lonely performer for GE in 1Q 08

 In 1Q 08, Commercial Finance and GE Money profits declined 20% and 19% respectively dragging the overall performance of the company. In addition, the Industrial and Healthcare segment recorded decline in profits. Industrial and healthcare segment recorded a decline of 16% and 17%, respectively resulting lower than anticipated EPS in 1Q 08. The infrastructure segment which reported strong profit growth of 17% and the NBC Universal which recorded profit growth of 3% were the only saving grace for GE in the first quarter of 2008.

 

GE’s international revenues grew 22% primarily driven by emerging markets, while revenues from the US declined by 5-6%. The industrial organic growth of 5% (including 2% due to currency) was partially offset by a decline in growth at financial services. Infrastructure segment led the way reporting organic growth of 14% in 1Q 07. In the light of the abysmal performance by GE in 1Q 08, the management lowered the full year 2008 EPS guidance to US$2.20 to $2.30 as compared to US$2.42 in FY 2007, and 2Q08 EPS guidance of $0.53–0.55.

 

Loss provisions to rise in coming quarters as more pain in financial services business

The current loss provisioning stands at 1.3% (1Q 08 annualized) of the total financing assets of GECS increasing from 1.0% in 2006. Considering, we are in the very early stages of the consumer finance delinquency cycle; we anticipate the provisions for losses to continue its upward trend. If we consider the historical high the provision in a recessionary market as we currently are in, the loss provisions could touch 2% of financing assets as witnessed during the 1990’s recession. The GECS financing assets has grown significantly in the last four years at a CAGR of 11.7% to US$385 billion. The financing assets have further increased to US$418 billion.

 

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At the December 2007, total financing assets comprised US$390 billion, with Commercial Finance segment and GE Money segment accounting for 48% and 45%, respectively. The Commercial Finance financing assets consisted of Equipment and leasing assets (US$89 billion), Commercial and Industrial (US$59 billion), and real estate assets (US$40 billion). The GE Money financing assets consist of Non US residential mortgage (US$74 billion), Non US Installment and revolving credit (US$34 billion) , US installment and revolving credit (US$29 billion) and Non US auto finance (US$27 billion). Considering the huge financial asset base and exposure in the US markets and the real estate assets, it is highly likely that the provisioning for losses could further increase in the coming quarters.  

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Debt to equity and leverage ratio of GECS continue to rise

GECS debt to equity ratio has been rising in the last few quarters as profitability comes under pressure. The debt to equity ratio has increased from 6.5x in 2004 to 9.3x in 1Q 08. The total borrowings have grown at a CAGR of 12.2% in the last four years. The total borrowings has increased to US$536 billion in 1Q 08 from US$321 billion in FY 2003, with short term borrowings accounting for US$198 billion in 1Q 08. The significant rise in borrowings has seen the GECS debt to equity ratio expand to 9.3 times in 1Q 08. In addition, GECS leverage ratio is also beginning to rise from 10.6 times in 2005 to 11.8 times in 1Q 08.

 

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Increasing defaults in Commercial Finance and GE money segments

The rising default rates in the consumer finance business in the US will continue to challenge the credit expansion activities in the US. The delinquency rate in the GE money segment increased to 5.64% in March 2008 as compared to 5.22% in March 2007.  The rise was driven primarily in the GE Money’ US business where the rate increased to 5.75% from 4.72% in March 2007. In the commercial finance segment, the delinquency rates have increased to 1.36% in March 2008 from 1.26% in March 2007. Considering the worsening macroeconomic conditions, the rising unemployment levels and surging inflation, the default scenario in the US is more likely to get worse then better. GE deriving almost 50% of its revenues from financing business is likely to face tough times in the near future.

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Exposure to subprime credit

The company had an exposure of US$1.6 billion to sub prime credit. These investments are collateralized primarily by pools of individual direct mortgage loans. The default rate on the latter can be quite high considering the current credit crunch situation. Approximately one third of the US managed portfolio including credit card, installment and revolving loans were receivable from sub prime borrowers. This sounds very disturbing as these loans will be under severe stress in the coming times as the defaults from these subprime borrower increases. In mid 2007, due to the US subprime crisis, GE money sold its US mortgage business - WMC.

 

Significant real estate exposure in the commercial financing segment

GE has US$87 billion of real estate assets a mix of equity which is physical real estate and debt which is financing to third party real estate investors. GE is in the process of transitioning the mix of real estate earnings from lumpy gains as its trades the equity portfolio, towards a more predictable stream of income from third party financing. The recent troubles in the real estate market which is under severe pressure with tight credit conditions and lack of potential buyers is putting downward pressure on prices.

 

GE’s real estate assets at March 31, 2008, increased US$7.3 billion, or 9%, from December 31, 2007, of which US$1.1 billion was real estate investments, which increased 3%.  During 1Q 08, GE sold real estate assets with a book value totaling $1.7 billion which resulted in net earnings of US$0.5 billion. GE’s real estate net earnings declined US$0.1 billion compared to 1Q 07, primarily as a result of a US$0.1 billion decrease in net earnings from sale of real estate investments. This decline was mainly due to the increasingly difficult market conditions experienced in the 1Q 08.

 

Non earning receivables also continues to expand

GECS non earning receivables defined as those financing receivables which are 90 days or more past due. The non earning receivables for commercial finance segment have increased from US$1.6 billion (1% of financing receivables) in 2006 to $1.7 billion (0.9% of financing receivables) in 2007. In 1Q 08, the nonearning receivables has increased to US$1.99 billion which is 0.92% of the financing receivables from 1.05% in 1Q 07.

 

For the GE Money segment, non earning receivables have increased to US$3.7 billion in 2007 from US$3.2 billion in 2006. It has further increased to US$4.17 billion in 1Q 08. The total non earning receivables in the GECS has increased to US$6.2 billion in 1Q 08 from US$4.9 billion in 1Q 07, representing 1.47% of financing assets in 1Q 08 as compared to 1.48% in 1Q 07.

 

Off balance sheet securitization entities of US$ 54 billion

GE also has significant off balance sheet securitization entities of US$54 billion. which is 94% of the shareholder’s equity of GECS. Most of its exposure in the securitization entities is receivables is secured by credit card receivables of US$23 billion, followed by commercial real estate which is US$9 billion and equipment of US$6.6 billion.

 

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GE Capital Corp CDS performance

GE Capital Corp’s CDS spread has widened considerably in the ongoing credit turmoil touching an high of 192 basis points in March 2008. The widened CDS spread denotes the increased stress in the US credit markets in the month of March 2008. In the month of April the 5 year CDS spread again spiked in the wake of poor 1Q 08 quarterly results missing the guidance and the market expectations.  Currently, the GE capital corps CDS spread is around 102 basis points.

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GE is divesting itself of its appliance business and the Australian mortgage business  

GE announced last month that it plans to sell or spin off its Appliance business. The appliance division has revenue of US$7 billion in 2008 and employs about 13,000 people worldwide. This is inline with GE’s strategy of exiting the slow and no growth businesses. GE is also looking to sell its Wizard mortgage unit in Australia as part of its broader plan to pull back its consumer finance business. This denotes GE’s intention of reducing its exposure in the mortgage business as the troubles in US mortgage business spreads across the globe.  

 

GE raises US$8.5 billion in biggest bond sale since 2002

GE in less than a week after it reported a 12% decline in profits in 1Q 08, have sold US$8.5 billion of bonds, the largest U.S. corporate offering in six years.  GE paid the highest yields since early 2002 due to tough credit market conditions. The yields were in the range of 4.8% to 5.875% depending on different maturities. On 22 May 2008, GE Capital Corporation sold US$1.5 billion of samurai bonds in four tranches yielding in the range of 1.95% to 2.885%.