Investors worldwide are anxiously watching General Electric as the industrial conglomerate restructures and shrinks in an attempt to emerge from a full-blown crisis of mounting debt, cash-flow issues and underperformance in its Power division.
The company’s stock, already well underwater for 2018, has fallen 30 percent since Larry Culp became CEO on Oct. 1. GE shares are trading well below $8, but Wall Street analysts continue to slash their price targets for the stock.
The company has announced a plan to remedy the situation that centers around selling off low-performing units while focusing on its strengths, such as power plants, jet engines and health care products. The company appears to have sufficient liquidity to execute the plan.
GE should be able to generate sufficient resources to deleverage its balance sheet and meet contingencies while improving Power segment results — but risks remain.
How Did They Get Here?
A charge in the fourth quarter of 2017 required a near two-fold increase in GE’s GAAP reserves to $16.5 billion, underscoring the extent to which it had been under-reserved in its book of long-term-care insurance, which underwrites policies for things like home health aides and nursing home stays.
This charge and the continued underperformance of GE’s Power business have led to higher leverage and lower cash flows. As a result, the ratings agencies have downgraded GE’s corporate rating and commercial paper rating to BBB+/Baa1 and A2/P2, respectively.
Meanwhile, GE has more than $100 billion in corporate bonds outstanding, making it one of the largest corporate capital structures in the high-grade universe. The company’s industrial businesses alone have $63 billion of debt on the books.
Calculations by Moody’s reveal that GE’s total debt, including pension liabilities, has almost tripled since 2013.
GE has announced plans to reduce net debt by some $38 billion over the next few years while sacrificing only $5 billion of EBITDA.
The company has completed the sale of its distributed power business for $3.25 billion and 20 percent of its shares in Baker Hughes for $3.8 billion.
Other major moves planned by GE include reducing its quarterly dividend to $0.01, which will free up $4 billion of cash per year; selling its remaining 62.5 percent stake in Baker Hughes, resulting in roughly $15 billion in debt reduction; divesting its distributed power business; and the merger of the company’s transportation business with Wabtec, resulting in roughly $5 billion in cash and a loss of approximately $1 billion of EBITDA.
GE is also separating its health care business, transferring $18 billion in debt in the process, and reducing its pension obligation by $7 billion through a 93-basis-point widening of 10-year Single-A corporate spreads (although it still is well short of funding its $100 billion pension liability).
Management feels these actions will address the near-term leverage issues facing the company, giving them time to turn the Power business around and improving profitability and cash flow.
What About Liquidity?
GE has $13 billion in cash at GE Capital and $9 billion in cash at GE Co., along with $40 billion of revolving credit. As a result, the company likely has enough financial resources to meet its funding needs.
The commercial paper program may be constrained to $5 billion with the downgrade to A2/P2, but revolver availability should be able to cover any near-term needs.
What Are the Risks?
Although GE appears to have sufficient resources to deleverage its balance sheet and meet contingencies, recent market volatility highlights the company’s execution risk. Large drawdowns in equity markets could pressure valuations and pinch cash generated from asset sales.
The company could also face further downgrades as it enacts its plan. While downgrades are certainly possible, a three-notch downgrade to high yield (where GE paper is currently trading) is unlikely at this point.
Both Moody’s and S&P made positive comments regarding the sale of the 20 percent share of Baker Hughes, noting that it demonstrates GE’s focus on increasing cash balances and deleveraging. As a result, Moody’s and S&P could provide some time for the company to enact its plan before putting it on review for a downgrade.