GE: Back from the Brink

07/26/2013 7:00 am EST


Jack Adamo

Editor, Jack Adamo's Insiders Plus

As a proxy for the market, we are buying share of General Electric; the company's prospects are better than the overall economy's, plus it has a 3.2% dividend yield, which is an incremental positive, says Jack Adamo of InsidersPlus.

The General Electric Company (GE) just reported Q2 earnings. They were bad, but some of the forward guidance was encouraging, particularly the order book.

The backlog of equipment and services at the end of the quarter was its highest ever, at $223 billion, up $7 billion from the first quarter. That's only a 3.2% rise, but it's going in the right direction, and infrastructure order pricing rose 0.9% for the quarter.

Due to the slowdown in commodities, input costs have moderated, so that's another positive. Six of the company's seven industrial divisions saw increased operating profits for the quarter and the planned 70 basis-point (0.7%) enterprise-wide margin improvement for the full year seems to be on track.

Q2 operating EPS were down 5%, GAAP EPS were up 3%, and GAAP EPS from continuing operations were down a nasty 9% to 31 cents a share. Hence we have to buy into the optimism expressed above to take the plunge here.

Analysts expect adjusted earnings of $1.66 in 2013 and $1.82 in 2104. The expected increased earnings may not be easy to achieve without the discontinued operations. Most of those came from the downsizing of GE Capital, which is a very profitable division.

Nonetheless, the ongoing reduction of the financing unit is a positive. As a stand-alone, it would be the seventh largest bank in America, and its capitalization leaves a lot to be desired.

During the financial crisis, its liabilities brought the company to the brink. Warren Buffett helped bail it out with a $3 billion investment at very generous terms for the Wizard.

GE's enterprise-wide total debt comprises 82% of capitalization (per 2012 10-K). Its debt service is excellent, with interest coverage more than 13-times pre-tax earnings, still the finance division remains a source of balance sheet vulnerability, and I applaud management's initiatives to downsize it.

The planned continued sale of GE Capital assets will help both the quantity and quality of the company's liabilities. GE ended the quarter with $89 billion of cash and cash equivalents.

I'm okay with the recent acquisition of Lufkin Industries for $3.3 billion, and another small acquisition, but the ongoing share repurchase plan is a sore spot with me, given the high debt levels. However, the stock market loves buybacks. We rate the stock a Buy up to $26.

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