3 Risks Facing General Electric Company
Investors looking for stable, reliable companies often flock to blue chips like General Electric for a healthy stream of earnings and dividends. Yet, as we learned all too well in 2008, even the General Electric's of the investing world can get blindsided by a debt-fueled market frenzy.
Now that GE's banking fiasco is squarely in the rearview mirror, it's no less important for investors to keep an eye on the risks facing this industrial giant. As a shareholder, here are a few I will be watching closely in the year ahead.
Risk No. 1: A lopsided global economy.
General Electric's ability to grow revenues will be largely dictated by economic expansion around the world. While that's true for many companies, it's especially true for a diversified conglomerate like GE. Shares of "the General" historically track the performance of the S&P 500 more closely than just about any other blue chip. Because of its diversification across manufacturing, energy, banking, and transportation, GE is like a small slice of the broader U.S. economy.
With that in mind, the good news is that the U.S. economy is humming along quite nicely. The International Monetary Fund recently cited a marginally stronger American economy as an important component in its estimate for global economic growth of 3.7% in 2014, up from 3% in 2013.
Still, continued weakness in emerging markets or a slowdown in China will drag on GE, even though two-thirds of revenues stem from Europe and America. The Pacific Basin and the Middle East/North Africa regions were the only two that increased as a percentage of sales for General Electric during the last decade. Their annual rates of growth: 8% in the Pacific Basin and 13% in the Middle East/North Africa. Meanwhile, GE's total revenue growth schlepped along at a lackluster 1.1% rate during the past decade. To be frank, GE needs a healthy economy in every region to squeeze out any kind of top-line growth going forward.
Risk No. 2: An unclear future for GE Capital.
As I've pointed out before, I think GE's managed to "rightsize" its banking arm, GE Capital, over the past few years. The company's made all the appropriate moves and now plans to spinoff part of the consumer finance business in what will be the largest U.S. initial public offering since Facebook's debut in May 2012. This, too, is the right move for investors and GE's approaching it in a two-step process: First, a spinoff of the North American retail business; second, the other 80% of the consumer business will reach the chopping block in a tax-free spinoff likely to occur in 2015.
From my perspective, all of this is fine and well so long as the spinoffs are managed well. The disposition cold take a significant amount of management's time and efforts and could actually be a near-term drag on the company's core industrial businesses. For example, GE will need to repurpose cash proceeds from the first spinoff to strengthen the consumer finance balance sheet for the subsequent and much larger IPO. So the spinoffs should ultimately payoff for GE's new industrial-focused portfolio, but it might take a few years to play out.
Risk No. 3: A lingering pension liability.
Industrial firms like General Electric employed vast numbers of Americans during the past few decades; over time, those employees accrued significant benefits. Only a few years ago in 2011, inflated pension costs crept up on GE and weighed on earnings per share by 13 cents. GE noted in its presentation that "pension costs have grown driven by non-cash amortization distorting operating performance."
Basically, the costs reflected in results were higher than normal because of investment losses that occurred during the 2008 meltdown. And that continues to be the case. General Electric recognized an amount associated with those amortized losses in 2012 as well. Along with lower discount rates, the amortized losses have resulted in a total pension cost that's increased at an average rate of 26% over the past four years.
Total pension expense
Now, in a rising-interest-rate environment GE's pension deficit -- to the extent that it exists in a given plan -- will shrink over time, and GE attested this occurred in 2013. Nevertheless, investors should keep an eye on GE's pension costs going forward and specifically whether the company will need to divert hefty cash payments toward the plans.
A Foolish takeaway
GE, like any other company, faces risks in what CEO Jeff Immelt calls a 'new normal' operating environment. The days of highly predictable quarterly results are in the past, and GE's sheer breadth subjects the company to volatility in different industries and geographies. Fortunately, management seems attuned to these risks and has a long-term vision for the company. With a dividend yield that's 50% higher than the industry average, investors can take comfort in a steady income stream even if some hiccups occur along the way.
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The article 3 Risks Facing General Electric Company originally appeared on Fool.com.Isaac Pino, CPA, owns shares of General Electric. The Motley Fool recommends Facebook and owns shares of Facebook and General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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