Showing posts with label General Electric. Show all posts
Showing posts with label General Electric. Show all posts

Thursday, July 10, 2008

Reggie on GE

Reggie Middleton has done a fairly thorough analysis of GE. His picks as to the good bits and the bad bits is not dissimilar to mine. The worst bit is real estate - which he thinks deserves a big write-down.

None of the rest is seriously problematic - but he thinks it deserves low multiples. For some of that - fair enough. For other parts I think GE financial has some truly superior positions deserving of a higher than average multiple. But my disagreements here are minor.

He also puts relatively low multiples on the industrial bit - which he thinks grows but nothing like as much as I think.

In his uber-bearish way he gets GE being fair value now.

I think- and maybe I am just old fashioned - that the infrastructure bit of GE - which grows super-fast and has the most massive tailwind - is worth more than 5% market premium on the average American manufacturing company.

And if the blue-sky bits work (ESBWR reactors, Cameco JV, ultra light jet engines etc) then a 5% premium will seem very light.

And that is the extent of our disagreement.

If you are into GE I recommend reading Reggie's piece.

Tuesday, July 8, 2008

Christmas in July: a falling US dollar is just a bowl of cherries

Australia is sweltering hot at Christmas. Everyone sits down with extended family when it is 40C (104 Fahrenheit) and indulges in an excessive roast lunch. Christmas is sweat and family dramas.

The saving grace of a mid-summer Christmas is cherries. The cherries are just coming on in December and are fantastic. You buy boxes at roadside stalls as you drive the long distances to your home town and eat half before you see your family.

A Winter Christmas

There is a new emerging Australian tradition – which is to have a winter Christmas celebration. Christmas in July is hams, puddings and wood fire. This new tradition is really strong amongst Australians who have spent some time in the Northern Hemisphere and pine for a white Christmas.

But Christmas in July is without cherries and that doesn’t feel quite right.

Until now.

On Saturday night my wife and I went to a delightful Christmas in July. This was a stylish affair with fairy-tale lights and good bubbly wine. And we took a bowl of cherries.

The cherries came from California. And they were $15 a kilo (say $7 a pound) at Paddy’s Market. Five years ago they were unaffordable. But then the US Dollar halved relative to the Australian dollar and now we have affordable cherries in the depths of winter.

Cherries and the US current account deficit

And as I indulge in another bowl of cherries I think the falling US dollar is wonderful. And so does some Central Valley farmer. Of course my (incremental) purchase of American cherries drives the price up for most Americans (poor you). And so in the smallest of ways there is a shift in the American economy from US domestic demand to exports.

Exports are the only part of the US economy doing well. Export driven businesses are shooting the lights out. (If you don’t believe me read the Federal Reserve’s Beige Book.) If there is a single really good global trend it is away from US domestic driven businesses and towards US export driven businesses. It is symmetrically against foreign businesses that compete with US exporters. (Think GE over Siemens, Boeing over Airbus.)

The Bronte Capital thesis on this is as follows:

  • The US current account deficit is huge
  • The subprime crisis has shown that you can’t endlessly and profitably lend to American consumers therefore the economy will need to shift to radically bring down the current account deficit.
  • This means you need to avoid US domestic sectors and fall in love with US export driven sectors.
  • Alas rising oil prices are driving up the current account deficit slightly faster than the changing terms of trade are driving it down which means we are only beginning on the export driven trend.

If you want a decade long trend its US exports.

You should be on it. And life will be a bowl of cherries.

Thursday, June 26, 2008

Saving a General with a fresh set of batteries

Mish asks today whether battery technology (and electric cars) can save General Motors. I think that answers itself.

But maybe Mish is focussing on the wrong General. GE is doing really interesting things with hybrids and GM is merely hoping to come along for the ride...

One of the big problems of the Prius is that it has very limited towing capacity. The specifications are essentially none.

The other American General (Electric that is) is working on mega-hybrids - busses and would you believe tug boats. No lack of grunt there.

Not quite the profit making potential of low costs nukes (see ESBWR). But hey - mega-batteries, public transport and low cost nukes. That is an American future.

GM will try to tag itself on - the dream GM electric car will use those batteries. But the profits will belong to the other General.

Sunday, June 22, 2008

Steve and Barry's and what the #$%@#% is GE doing

Only a few days ago I expressed complete puzzlemement over a $125 million dollar loan that GE had made to Kinney Drugs. Here is my post - and here is the GE press release.

This was not a one-off. In March this year GE provided almost $200 million to Steve and Barry's.

That loan is already rumoured to be default - and Mish - bless him - has pointed out just how much of a Ponzi scheme Steve and Barry's turns out to be.

Mish concludes by saying:
If it seems like GE trades like a finance company, it's because GE is a finance company (masquerading as a conglomerate).
In this case Mish is probably right. The two press releases (Kinney Drugs, Steve and Barry's) have the same contacts:

Jeff Wilson
+1 203 229 1887
Jeffrey.Wilson@ge.com

Ned Reynolds
+1 203 229 5717
+1 203 837 0699(mobile)
ned.reynolds@ge.com
You got to wonder about an asset backed (which I think means stock backed) loan for $200 million which goes bad in four months.

The first question for Messers Wilson and Reynolds is what GE is going to do with $200 million of cheap apparel.

The second question: why does this business continue to exist - and who gets fired?

Mish's general assertion however - that GE is a finance company masquerading as a conglomerate is wrong. They can turn Italian crap into electricity - and no finance company can do that.

They might have a worse time though turning Steve and Barry's old rags into cash.

John

Wednesday, June 18, 2008

Its time for a short version of yesterday's post

Got lots of emails about gnarly little things in GE Capital. Those appear to be true of all financials. Nothing that really stresses me - but the miss in GE Capital in the last quarter is probably not the last miss.

But the post really comes down to this. There are two GEs - the beautiful one and the ugly one.

How about I give you both from Michigan.

GE is installing a nuclear reactor for Detroit Edison. The press release is here.

This is a really special nuke. The design is new. The costs are (supposedly) much lower than conventional light water reactors and the safety level higher. The GE spiel is reproduced in this Wikipedia article.

If GE can produce a nuke that is (a) much cheaper and (b) much safer than the existing stockpile then they will rule the roost. That is a business proposition that should make you salivate. If the US gets serious about greenhouse gasses then there could be an awful lot of coal and gas replacement.

[Any engineers out there wish to comment on GE's specs? I am not an engineer and I have been fooled by engineering stocks before. GE is however usually fairly good at their engineering word.]

Just up the road GE is trying to sell a 400 home multi-family. I am not rigging it. Half the housing GE is trying to sell on its website is in Michigan.

Here is a picture.



The home price in that zip code (48192) has not gone to zero - but is not high. Try this search. Note that the most expensive home in the zip is about USD250 thousand.

GE sure is a pretty girl to be found in this house. Don't really know what she is doing there.

John

Tuesday, June 17, 2008

What’s a nice girl like you doing in a place like this? A comment on General Electric’s corporate lending business

Avid readers will know that I rather like General Electric at these prices.

Here I point out just how good the weak USD is to them.

And here I point out just how fantastic GE’s asset sales have been. [Just imagine if GE still owned FGIC and Genworth. The former is in deep trouble. The latter is merely problematic.]

Regular readers will also know that I subscribe to the GE press-release blog which you will find here.

But when I am long a stock I always look at what is wrong with the story. Indeed the central investment trap I fall into is to ignore the positives in my shorts and ignore the negatives in my long. This post is a conscious effort to correct that.

The negatives

With GE I point to a few negatives:

  • The acquisitions in medical have a head-scratching character – as Jeff Matthews points out here.
  • The domestic media business is not exactly great either.

Indeed my summary of GE is as follows:

  • If it is US domestic driven it is bad.
  • If it is export driven it is good
  • If it something China needs, where the competitor is European and where GE produces the most thermally efficient product it is stunningly good. There are plenty of examples in GE.
  • If it is consumer finance it is much better than it would have been had GE not taken all the asset sales (but remains problematic), and
  • If it is corporate finance driven its not bad to the best of my knowledge but I am left scratching my head about bits of it.

So I get a little puzzled at this press release.

In it GE announces that it has lent Kinney Drugs $125 million secured by some undisclosed assets to finance (of all things) the employee stock ownership plan. My interpretation – GE is financing the exit by the existing management of part of their holding – purchased by staff.

Apart from the fact that this deal reeks of late 2006 early 2007 when financing LBOs was all a rage it is very hard to see what GE brings to the table other than spondulick$.

But first let me digress into good-and-bad corporate finance businesses at GE and elsewhere.

Xerox – the model of a bad corporate finance business

Once upon a time (that is just a few years ago), Xerox used to sell lots of copiers to small businesses. Their once-grand marque had been superseded by the Japanese. There was no particular reason to buy a Xerox copier over a Fuji or a Ricoh or Cannon or any of a few brands. Xerox had inferior technology in colour and had formed a joint venture with Fuji (Fuji-Xerox) to sell that stuff. This was mostly a mix of Fuji technology and Xerox distribution.

This all appeared to work well. The copiers were sold by salesmen with maintenance contracts – which were really finance contracts. The sales kept up with something reasonable and the stock was fairly strong.

The problem was that the inferior technology and price proposition was being masked by a superior sales proposition led by credit. A large number of customers (small businesses and the like) shopped with Xerox because they did not have the finance to buy from another supplier.

To tell this as an investor you probably needed to get your fingers dirty and study the business well. It was not easy. But the problem sequence was a classic – with minor problems in the finance business leading to a tightening of credit standards and a loss of sales. The stock came crashing down. The stock went from over $60 to under $5 in a matter of months wiping out a decade of good (but in retrospect dodgy) gains.

It is iconic in investing that you need to be very scared of any manufacturing business which sells inferior technology to inferior credits backed by its lending business. Some would also say the Lucent backing of One-Tel (a bankrupt Australian mobile phone company) was the same sort of arrangement.

By contrast let’s describe some good equipment finance businesses:

  • Suppose you have the superior product (say the most fuel efficient jet engine) and
  • Suppose the product needs regular contracted maintenance or it kills people (such as a jet engine) and
  • Suppose the product is able to be repossessed and resold and because you have the best distribution system you have the best ability of anyone to repossess it. Besides because of the maintenance schedule you know exactly where it is (like a jet engine).
  • Finally suppose that the technological obsolescence cycle is say a decade or more so when you repossess it the product is worth something – so you can’t be stuck in the position that Lucent was when it repossessed One-Tel’s mobile phone system. Hey – like a jet engine.

Then you have the makings of a truly brilliant finance business. It can make good money almost regardless of the economic cycle of its customers.

Notice that this finance business does not even require the airlines to be solvent. It only requires that the product has a technological edge, can be repossessed and does not lose too much value when remarketed. Moreover the best sales network for new product is also probably a good sales system for repossessed product. GE has a competitive advantage in engines (which I think is beyond dispute), is good at selling them and hence has a competitive advantage in financing them.

There have been lots of airline insolvencies but the GE finance business skated through unscathed.

One step down from jet engines is say how the hospital business works. GE sells big kit (x-rays, cat scans, MRIs etc). The kit requires installation and training to work (which sounds like a jet engine). The buyer is a hospital or a consortium of doctors. The finance of the hospital is sometimes difficult – but even when they go bust they continue to operate. The kit requires some staff training to use and some maintenance.

If you have a superior finance/training package the hospital administration will buy your package. You will clip the coupon when the patient (or their insurance) pays several hundred dollars for a scan. Its going to be less good when the government cuts back on medicare rebates for radiology. But it is not the sort of business that can really kill you. GE can sell the equipment offshore. People still need their MRIs and the equipment can be repossessed without baseball bats.

It’s a good finance business then if what you bring to the table is adequate technology, the ability to repossess, and the customers are the sort that are not going to default. That is what the medical business looks like.

That is – to the best of my knowledge – most of GE commercial finance. [It is not the state of their consumer business. The consumer business is far more problematic but I do not believe can really hurt.]

The credit data in the last accounts suggests that the credit at GE commercial finance is not too bad. The conference call transcripts note that commercial finance delinquencies are 136bps up 10bps from a year ago – which was historic low levels. I have been comforted by that – there being no obvious problem in commercial finance.

Well there is one obvious problem in commercial finance – the real estate business.

The commercial finance business owns quite a deal of straight property as well as loans. The owned portfolio is about 40 billion worth. They used to roll a bit of this off every quarter – and lo-and-behold make a profit. Pure speculation in my view even though the annual report describes GE has having world beating expertise in commercial property.

General Electric found out last quarter that they couldn’t do the deals towards the end of the quarter – and that was – according to the conference call transcript – the most obvious problem in the finance business and the core reason for the failure of GE to meet its earnings even after guiding well a few weeks prior. Here is an extract from the conference call:

Jeff Sprague - Citigroup – Analyst and one of Wall Street’s Finest

I guess one thing we will all be struggling with here today is just trying to get comfortable that we have got a baseline we can have some confidence in and I guess just a couple of things that I am wondering is although you are looking for lower gains, if you could give us some sense of how important gains still are in your earnings outlook for the remainder of the year?

Keith Sherin - General Electric Company - Vice Chairman & CFO

I think the biggest place here is real estate, obviously, Jeff. If you look at our real estate book, about 50% of the assets are debt and about 50% are equity. The real estate business made about $2.3 billion last year as I said. They are going to be down somewhere between 15% and 20% we would anticipate and the gains are going to be 60% of their year probably. So we are selling a lot of real estate. We are lowering what we thought we would have. We had as we entered the year an embedded gain of over $3 billion in the properties that we have. We have still got a pretty robust global market, but we are counting on real estate property sales as part of that business model to continue to be a significant piece of those earnings.

At the same time, all the investment we are making is on the debt side of the business to remix it and that gives us more of a spread business going forward. So we sat down with Mike Neal and Ron Pressman and the commercial finance team. Obviously, we spend a lot of time on this and these numbers take into account the pressure they have seen and what they think will happen as we go forward on real estate. And certainly as far as visibility into the second quarter, we think we have got our hands around what the second quarter looks like and we have got pretty good confidence on that for commercial finance. So there is still more in the quarter to get done and more in a year to get done, but we think we have captured what that exposure is for us.

Now I know the transcript is a mess – but that is the final transcript as downloaded from the GE website. (Does anyone read these things?) But the earnings from the real-estate business are in my view going away. That is $2.3 billion (pre-tax) that is disappearing. That will offset – at least this year – most of the good stuff.

This business has a (profitable) past. At one stage – unbelievably in my view – well over a percent of GEs profits came from self-storage facilities. They sold most of them for big profits.

Lets get really horrible and assume the real estate business is all bad. The real estate bit has been an increasing part of GE Commercial Finance. This is the extract from the last annual report:

There are 79 billion in real estate assets – about half loans and half equity according to the conference call transcript above.

That does not look pretty. If the real-estate falls by 30% (which does not seem unreasonable) then the debt is probably worth 90c in the dollar (for a loss of $4 billion) and the equity gets cut by the full 30% (for losses of about 12 billion). These losses would be offset by the $3 billion in unrealised gains as at the end of the year – but the pre-tax losses would be about 11 billion compared to 26.5 billion of pre-tax earnings (24 billion before the real estate business) for the whole of GE.

Nothing here looks unmanageable – but the possibility that GE loses six months income – say $13-15 billion pre-tax on this business – is not zero. The bears out there (and there are plenty) would think it likely.

If you look at GE Real Estate’s website http://property.gerealestate.com/ and you click through to property for sale (which is stuff they own) there is not much. Indeed when I clicked through there were only 4 properties in the whole USA – but they were all duds. Indeed they were all multi-family residential including such gems as a 200 apartment building in Michigan. (If you read my post on Royal Bank of Scotland and Charter One you will know what I think of Michigan.)

But the encouraging part of this is the website only has 4 properties for sale in the USA. According to the last annual apartment buildings were only 14% of a 40 billion dollar portfolio. Half was office buildings and only half was in the North America.

This can hurt but it cannot kill. However if you don’t expect GE to take some (large) charges you are not thinking. Here is the disclosure from the last annual report:

REAL ESTATE: . We review our real estate investment portfolio for impairment regularly or when events or circumstances indicate that the related carrying amounts may not be recoverable. Our portfolio is diversifi ed, both geographically and by asset type. However, the global real estate market is subject to periodic cycles that can cause significant fluctuations in market values.

While the current estimated value of our Commercial Finance Real Estate investments exceeds our carrying value by about $3 billion, the same as last year, downward cycles could adversely affect our ability to realize these gains in an orderly fashion in the future and may necessitate recording impairments.

(Memo to Jeff Immelt. We are waiting. Accounting integrity here = charges.)

The other ugliness in GE Commercial Finance

There is in my opinion no real reason why GE is in direct real estate ownership. They don’t seem to bring anything to the table except a AAA credit rating. But hey – I can own real estate myself. The obvious thing to do is to sell the real estate – take the $10 billion charge and use the 30 billion freed up to buy back another $20 billion in stock. I can’t see under any reasonable circumstances – why GE is capital impaired if they take $10 billion in charges.

But the press release at the beginning of my article – that is a real head scratcher. I will repeat it all here.

GE Corporate Lending Provides $125 Million Asset-Based Credit Facility to Kinney Drugs

NORWALK, Conn.--June 3, 2008--GE Commercial Finance Corporate Lending today announced it provided a $125 million asset-based credit facility to Kinney Drugs, a NY-based drug store chain. The loan will be used to fund the company’s employee stock ownership plan. GE Capital Markets arranged the transaction. GE also provided the company with interest rate risk management.

Kinney Drugs opened its first store in Gouverneur, NY, in 1903. Since then, the company has grown into a regional drug store chain, operating more than 80 locations throughout NY and VT.

“We valued GE’s industry expertise specific to drug store retailing,” said Craig Painter, chairman and CEO for Kinney Drugs. “They worked closely with us to understand our needs and provided the capital to meet our requirements.”

"An in-depth knowledge of the retail sector means smarter capital for our clients,” said Jim Hogan, managing director of GE Corporate Lending's Retail group. “Whether the borrowing need is for working capital, acquisition finance, turnarounds or ESOPs, we are dedicated to finding the right solution to help companies execute their business plans."

Industry Specialization

To better meet the unique financing needs of customers, GE Corporate Lending has a team of Industry Leaders supported by research analysts. These industry experts help build smarter financing solutions for companies across key industries: Aerospace & Defense; Automotive; Chemicals & Plastics; Construction; Food, Beverage & Agribusiness; Financial & Business Services; Forest Products; Metals and Mining; Restructuring; Retail; Technology & Electronics; and Transportation.

About GE Corporate Lending

With $16 billion in assets, GE Commercial Finance Corporate Lending is one of North America’s largest providers of asset-based, cash flow, structured finance and other financial solutions for mid-size and large companies. From over 30 offices throughout the U.S. and Canada, GE Corporate Lending specializes in serving the unique needs of borrowers seeking $20 million to $2 billion and more for working capital, growth, acquisitions, project finance and turnarounds. Visit www.gelending.com/clnews to learn more.

Can somebody please tell me what – if anything GE brings to the table here. I cannot work out a single reason why GE has a competitive advantage in this business. Its not turbines or tubine finance. Its not the good finance business I described above.

The only saving grace. This business is small.

Finally – its time for GE investor relations to contact me

When investor relations at a company like GE go “radio silent” its usually a very bad sign. Ambac went radio silent before they blew up. (I know – I like and still respect the former CEO Robert Genader. He didn’t answer my emails though.)

I have been trying to get GE investor relations to return my email. No luck. Will somebody please contact me.

My address is attached to the “about me” section of this blog.

If you don't allow a bull to tell the story then you leave the door open for the (usually prescient) Reggie Middleton to tell the story. Reggie is far more bearish than I would be.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.