The Turnaround That's Returning $90 Billion To Shareholders

Chris Walczak's picture

Friday, April 24, 2015 - 12:00pm

by Chris Walczak

It can take some companies many decades to grow large enough to merit a $28 billion market valuation. News that General Electric Co. (NYSE: GE) is transforming itself created that much shareholder value in just one day.  

What has the market so excited? GE announced that over the next two years it would sell off almost all of GE Capital's portfolio for an estimated $90 billion.

Longtime investors remember the sordid history of GE Capital. After more than 100 years of being an industrial and manufacturing powerhouse, the GE of the early 2000's scarcely looked like the same company. The company had charged into real estate, commercial and personal lending.

And for a while, it looked like GE's foray into finance was a rousing success. GE capital grew revenues 15% per year from 2003 to 2007 and the earnings from GE capital made up half of the parent company's earnings in that final year before the crash.

GE Capital's aggressive financial practices came back to haunt it during the financial crisis. Its struggles strangled the parent company and necessitated a lifeline, which Warren Buffett and the U.S. government provided to stave off insolvency.

But despite nearly bankrupting the company in 2008, GE did not fully wind down that division. Just last year, GE Capital contributed more than $7 billion to GE's bottom line, despite regulatory scrutiny and a more conservative approach by management.    

What Does The Sale Mean For GE Investors?
The short-term impact of this asset sale: GE will report significantly reduced profits as the divestitures occur. GE Capital's sole remaining function, post-divestitures, will be to provide financing when the company's industrial, energy and medical equipment customers buy GE's goods and services.  

This future drop in earnings is inevitable when a company is selling such a huge portion of its business for cash. But the company has announced that it will use nearly all the proceeds from the sale of the GE Capital to buy back shares. This will keep earnings per share steady despite the drop in overall earnings.

The long-term impact of divesting GE Capital's assets will be a huge win for shareholders. Firstly, investors in GE own several exciting industrial divisions that are growing quickly.  

The oil and gas division, which makes heavy industrial equipment used in drilling operations, was the crown jewel from 2010 to 2014. This segment boosted revenues and operating earnings by more than 15% annually over this time period. The recent drop in oil prices has tempered expectations for this unit over the short term, but oil and gas are a big part of GE's future.

GE's aviation division, maker of aircraft engines and turbines, is also showing impressive 12% growth in operating earnings since 2010. GE is in a plethora of other industrial businesses as well, from making locomotives to producing wind turbines and industrial products for nuclear power plants, among many others.

GE heavily invested into businesses with high barriers, while providing crucial infrastructure services and products that will be needed around the world for decades to come. The benefit of divesting GE Capital is that it allows management to focus on these businesses, while giving them the capital to make internal investments and earnings-inducing tuck-in acquisitions.

Secondly, the risk of a financial catastrophe akin to 2008 is greatly reduced without a highly-leveraged capital arm. Investors can be more confident that their investment in GE is safe. More investor confidence and less risk usually equate to a higher price-to-earnings multiple. The 3M Co. (NYSE: MMM), another industrial conglomerate with a similar profile to GE, trades for roughly 22 times trailing earnings per share, versus GE's current 18 times earnings multiple.

Risks To Consider: GE's strongest industrial division has been the oil and gas division. If oil prices stay depressed for an extended period, it will struggle to deliver the earnings growth its industrial arm has delivered in the past.

Action To Take --> GE's massive buyback will put a floor under the stock and the industrial businesses will deliver earnings growth for many years to come without the level of risk that comes with having such a huge financial portfolio.

The stock's 3.7% dividend yield rewards shareholders even if the price upside doesn't materialize immediately. GE has promising industrial divisions that can pick up the earnings slack should one area of the business face headwinds. This stock is a long-term winner.

Stocks like GE are similar to a special group of securities we call "Forever Stocks." These world-dominating companies control deep economic moats allowing them to fend off competitors. And they pay investors fat dividends, while buying back massive amounts of stocks, which boosts the value of their remaining shares. These stocks are strong enough to buy, forget about and hold forever. To learn more about them -- including some names and ticker symbols -- click here.

Chris Walczak does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.