Part II of GE story focusing on GE CAPITAL in Barron's weekday trader.
March 21st, 2002
GE Capital Should Withstand the Slings and Arrows
By Allison Krampf
Editor's note: This is part two of a series on General Electric, America's most valuable company.
If General Electric is corporate America, subsidiary GE Capital has been its money machine.
But like its parent, GE Capital is getting its share of criticism lately, mostly for its accounting.
Besides facing questions about its uses of special-purpose vehicles and off-balance-sheet financing, GE Capital got hit with a bombshell Wednesday, when the highly respected William H. Gross, manager of the PIMCO Total Return Fund, blasted its debt level, its big exposure to commercial paper and the amount of information it discloses to investors. (Gross manages the world's largest bond fund, with $53 billion in assets.)
GE's stock has lost about 3.5% of its value since Gross's report appeared, falling to 37.45 late Thursday in a weak market.
But these worries about GE Capital may be overblown, just like investors' concerns about GE itself, which Barron's Online discussed Wednesday (see Weekday Trader, "What's GE Worth? More Than Its Price," March 20, 2002).
"We look at more than just a ratio of bank credit lines and commercial paper" when giving out ratings, says Robert Young, a senior vice president in the Financial Institutions Group at Moody's Investors Service. "GE is a tremendously deep company, with good franchises, earnings performance and growth."
Moreover, he says, "we look to GE Capital's affiliation with GE…and its ability to tap into GE's resources, and other near-term sources of cash, such as bank facilities, and that provides us comfort" in giving it a Aaa rating, Moody's highest. (GE and GE Capital get top AAA ratings from Standard & Poor's as well.) He declined to comment specifically on Gross's report.
But GE did. In a statement issued Thursday, GE said big growth in assets late in 2001 left GE Capital with a disproportionate amount of commercial paper, which it pledged to reduce substantially by the end of the year. It also said it was committed to retaining its triple-A rating and that it would meet 2002 earnings targets.
GE Capital Services, whose assets now stand at $425 billion, is a far-flung financial empire involved in diverse businesses such as consumer services, including credit cards; middle-market business financing; real estate and structured finance; leasing, and specialty insurance.
GE Capital, which accounted for nearly 40% of General Electric's net income last year, "has been an important part of its overall growth and diversification strategy," adds Jeffrey Germanotta, analyst with William Blair & Co., who rates the stock a Long-Term Buy.
(Last week, GE Capital filed with the Securities and Exchange Commission to sell up to $50 billion in debt, preferred stock and other securities offerings, which apparently prompted Gross to sell $1 billion worth of commercial paper. In its statement Thursday, GE stressed that was a shelf registration, "not an offering.")
Some analysts and fund managers think GE Capital's growth will pick up as the economy recovers. And indeed, by issuing billions of dollars' worth of bonds now, before interest rates rise again, it could be locking in low-cost debt for years to come.
"GE Capital will continue to be a mid-teen earnings grower," says Benjamin Pace, portfolio manager with Deutsche Bank Private Bank. "A lot of us are forecasting 3%-4% economic growth, which benefits the businesses where GE Capital operates," such as consumer finance and card services. (GE accounts for about 4% of Deutsche Bank's model portfolio. The private bank manages roughly $9 billion in U.S. blue chip stocks.)
"GE Capital will continue to grow organically and through acquisitions," says Uma Rajeshwar, senior portfolio manager with Glenmede Trust. (GE comprises roughly 2% of his $400 million portfolio.)
But it may be holding off on big acquisitions for now. On Wednesday, the company denied any interest in acquiring The CIT Group, a financial subsidiary of troubled Tyco International.
Meanwhile, it may be looking to get out of the volatile reinsurance business by spinning off part of its Employers Reinsurance subsidiary. (Today, Employers Reinsurance announced it has formed a new global property & casualty insurance division.) GE Capital officials didn't return telephone calls seeking comment.
And while the Enron fiasco has led to hypersensitivity about companies' use of off-balance sheet financing, GE has tried to calm these fears. The company beefed up disclosure and further broke down GE Capital's different operating units in its recently released annual report. It also detailed its use of more esoteric securities, including derivatives, asset securitizations and special purpose vehicles.
"We were aware that the company was using special-purpose vehicles," analyst Germanotta says. "The added disclosures offered more insight and visibility, but raised no new concerns."
"I clearly believe it will give [investors] more comfort over time," adds Germanotta, who wouldn't say whether he holds GE stock personally but was not aware of any investment banking relationships between William Blair and GE.
At 37.45 late Thursday, GE stock is 30% off its 52-week high of 53.55, reached last May, and 38% off its all-time high of 60.06, which it hit in August 2000. It is changing hands at 22.5 times projected 2002 earnings of $1.66 and at less than 20x 2003 estimated earnings of $1.83.
Its 2002 multiple is still well off its median multiple of 31x forward earnings over the past five years, according to Thomson Financial/Baseline. And, as we pointed out Wednesday, it's at the lowest premium to the market multiple it's had since the 1990-1991 recession.
And GE's strengths may not be fully reflected in the company's stock price.
Analysts estimate the company can grow earnings by 15% annually over the long haul. GE's earnings will also get a boost from accounting rules that no longer require companies to amortize goodwill -- a significant factor in acquisitions. GE stock has a 1.8% dividend yield.
Analyst Sheelagh McCaughey of Morgan Stanley argues that GE deserves the median 30% premium to the S&P 500 it has achieved historically. Her target price: 50. (McCaughey owns GE stock, and Morgan Stanley has done investment banking for GE in recent years.)
Clearly, at least some of that historical premium was due to Jack Welch. GE's new CEO will have to persuade Wall Street that there shouldn't be a "Jeffrey Immelt discount." And GE Capital will have to remain a triple-A credit -- and GE's money machine.
But ultimately, GE's strategy of assembling different businesses that prosper during different cycles will mean steady growth year after year. Once Wall Street recognizes that, the house that Jack built will once again stand tall |
