General Electric (NYSE: GE) was founded by Thomas Edison as the Edison Electric Light Company in 1878 and has been a foundation of many investment portfolios for over 100 years. It is a diversified company with operating segments in power, renewable energy, aviation, healthcare, transportation, lighting, capital (financing), and oil and gas. However, over the past five years, the stock has been hammered and some investors believe that GE may be seriously in trouble.
These expectations are reflected in the performance of the stock which closed today at $8.57 down from a high of $13.25 this year and well below the $30+ prices from 2016. The Market cap at this price is $74.8 billion dollars which puts it just ahead of Enbridge (ENB) at $70.5 billion dollars (current stock price is $34.80). However, while ENB has $46 billion in revenue, GE has $122 billion in revenue. Why is a company nearly 3 times larger in sales worth about the same money?
Part of the answer comes from recent poor performance which will be seen in more details below in the financials. Most companies are valued at the price of their current assets plus projected value due to their sales and profit growth expectations. These valuations imply that the market believes that GE will continue to destroy the value of their company and Enbridge will continue to grow the value of their company.
GE’s latest news hasn’t helped. GE dropped its dividend from $0.24 per share in 2017 (3-4% yield) to $0.01 per share in 2019 (0.4% yield). While this helps GE save nearly $4 billion a year, the change caused many to sell their shares.
Also, on August 15th, Harry Markopolus announced that he found evidence of $38 billion in fraud from accounting issues in their oil and gas unit and through improper reserves for potential losses in their insurance unit. GE naturally says this information is false and Markopolus has admitted he created the report on behalf of a hedge fund that has sold GE short (sell the stock without owning it in hopes to buy it back to cover the trade at a later date).
I am interested in looking at GE’s financials to see if it might be a good value at ~$9 a share, so let’s dig into the income statements.
Revenue 2015 = $117.4 billion, Net LOSS $6.1 billion
From GE’s annual report financials
Revenue 2016 = $119.5 billion, Net Income $6.8 billion
Revenue 2017 = $118.2 billion, Net LOSS $8.9 billion
Revenue 2018 = $121.6 billion, Net LOSS $22.8 billion
Ouch, well those losses certainly contributed to the the stock drop! While the sales continue to be robust, there are huge costs coming from Goodwill impairments ($22.1 billion in 2018) and costs associated with discontinued operations $2.8 billion in non-operating benefit costs, $1.7 billion in losses from discontinued operations). Does this bleak picture continue into 2019?
3/31/19 Revenue = $27.3 billion, Net Income $3.6 billion
From GE’s annual report financials
6/30/19 Revenue = $28.8 billion, Net Loss $0.61 billion
Initially, it seems that GE might be turning around the losses, but it is not simple to tell from the income statements. Let’s look deeper into the balance sheet and cash flow. Since GE is so diversified, I don’t sense any special entry to follow such as inventory (TTS) or Receivables (ENB) that provide any clear picture of health or sickness. However, GE holds a lot of cash and investment securities which they can sell for cash, so I want to track those items on the balance sheet for liquidity analysis.
Annual:
12/31/15
Cash = $70.5 bil; Investment securities = $31.9 bil;
Assets = $493.1 bil; Liabilities = $390 bil
12/31/16
Cash = $48.1 bil; Investment securities = $44.3 bil;
Assets = $365.2 bil; Liabilities = $285 bil
12/31/17
Cash = $44.0 bil; Investment securities = $38.7 bil;
Assets = $369 bil; Liabilities = $292 bil
12/31/18
Cash = $30.0 bil; Investment securities = $33.8 bil;
Assets = $309 bil; Liabilities = $257 bil
Quarterly:
3/31/19
Cash and marketable securities= $73.2 bil; Assets $315 bil;
Liabilities = $259.4 bil6/30/19
Cash and marketable securities= $71.4 bil; Assets $312 bil;
Liabilities = $256 bil
Cash and investment securities are relatively stable with the large drops associated with large drops in liabilities. This implies that the cash was used to pay down debt. GE also has more assets than debt and the debt is limited to 300-400% of the available cash in the company – reasonable and solid ratios.
When paired with the income statement, however, it starts to become a little bit of a mystery. For example, between 2017 and 2018, GE lost $22.3 billion dollars – yet their cash only went down $18.9 billion between the cash and marketable securities? Where did the other $2 billion go?
Also, I want to know if these losses are real losses or paper losses. Here the difference is a bit nuanced, but it is a matter of determining if accounting entries (depreciation, goodwill impairment, etc.) are causing the losses to the income statement instead of actual business issues. Let’s look at the actual numbers and I’ll explain along the way.
Examining the details of the cash flows for 2016-2018 from the 2018 Annual report, we see:
2016
$7.2 billion in earnings
$1.2 billion of cash from operating activities
2017
$8.8 billion in losses
$6.0 billion in cash from operating activities
(yes, +6 billion despite losses of $8.8 billion)
2018
$22.4 billion in losses
$4.2 billion in cash from operating activities
(yes, +$4.2 billion despite losses of $22 billion)
What a strange picture! Usually, a $7.2 billion gain is far superior to a $22.4 billion loss, but I’d rather make $4.2 billion in cash than make $1.2 billion in cash. How can GE make more cash the year it lost more money? What are the main causes of that $26 billion dollar difference between the losses and the cash increase from operations?
This is also what I mean by real losses versus accounting losses, so this is a good time to explain and look at the usual suspects for accounting losses: depreciation and goodwill impairment.
Depreciation is the cost associated with the aging of an asset. For example, if one buys a new machine or builds a building, the machine or building will slowly wear down due to usage and time. This category does not include actual repairs or maintenance as those are actual expenses that hit the bank account. Think of depreciation as allowing the company to not pay taxes on the money it should set aside to pay for the next machine or the next building. However, there is no actual cash spent or lost from depreciation expenses! This is strictly an expense from an accounting point of view and what I called a ‘paper’ loss above. It only shows up on paper and not in the bank account.
In GE’s case, it recognized the following depreciation expenses:
2016 – $5.0 billion
2017 – $5.1 billion
2018 – $5.6 billion
Of that $26 billion dollar difference above, we just found $5 billion. Next, let’s look at Goodwill.
Goodwill is similar to depreciation in that it is an accounting mechanism and not directly related to a cash transaction. GE would gain goodwill in the purchase of a company as the amount paid for the company over the strict accounting value of the purchased company’s assets. For example, on April 20, 2017, GE purchased the 96% of ServiceMax (an IT company) for $867 million dollars (net after reducing the total amount by the $91 million in cash they acquired). Of this $867 million, $279 million is recognized as amortizable intangible assets (patents, websites, etc.) and $685 million is recognized as goodwill. Usually, goodwill is not reduced. However, when an acquired company or assets can be proven to be worth less than what GE paid for that asset, then they must recognize the difference as ‘goodwill impairment.’
GE’s Goodwill impairments from 2016-2018 are:
2016 $0
2017 $2.6 billion
2018 $22.1 billion
There’s more than the $21 billion in paper losses we were looking for in 2018! While there are other increases and decreases to operating cash, depreciation and goodwill impairment more than show that GE’s losses in 2018 were primarily accounting losses and never hit their bank accounts.
Do these losses continue into 2019? We would definitely expect depreciation to continue and it does: $1.2 billion in Q1 and $2.5 billion in Q2. Goodwill impairments relates only to specific events, so it might not continue. In fact we see $0.5 billion of impairment in Q1 and no impairment registered in Q2. That seems like a good thing!
However, the operating cash flow for Q1 is only $0.042 billion and for Q2 only $0.020 billion after actual losses from discontinued operations. These are meager results and it seems that GE is squeaking by more than it is turning the company around.
Therefore, I can’t say a $9 per share price is a bargain. Before I start putting money into GE, I’m going to have to see stronger signs of life in the cash flow and income statements. I’m rooting for GE, but not investing in it soon.