General Electric: A Case For Another 36% Haircut

Summary

GE shares are trading at 2.36 times book value, an unjustified premium above its peers.

GE has too much debt and is paying out more in dividends than it earns.

GE's 28 P/E ratio is too high compared to peers' 21 P/E ratio.

GE stock may fall to $13 per share but probably will bounce back fairly quickly

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By Michael Hooper

General Electric (GE) shares have fallen 33% so far this year, but the stock is likely to get cheaper. GE stock could fall another 36% to $13.21 per share because it has too much debt and is trading at an unjustified premium above its book value.

GE at $20.79 per share is trading at 2.36 times book value, versus Berkshire Hathaway (BRK.B) (BRK.A) trading at 1.54 times book value. GE has a lot of energy assets. One the largest utilities, Consolidated Edison (ED), is trading at 1.8 times book value.

GE has traditionally traded at a premium over BRKA, partly because GE pays a dividend and BRKA does not. But at a Nov. 13 analyst meeting, we will find out the future of GE’s dividend. I believe the dividend may be cut because the company is not making enough profit to cover both the dividend and its debt obligations. GE’s dividend payout ratio is 109%, which is unsustainable.

GE's long-term debt of $136 billion equates to $15.71 per share, according to an SA article by Travis Brown. Debt is 75% of GE’s capital structure, only 25% is equity.

Berkshire Hathaway has $102 billion in debt, which is about 25% of its capital structure and the other 75% is equity, according to Morningstar.

Book value of GE is somewhere around $8.80 per share. At 1.5 times book value -- the same multiple that the market has applied to BRKA -- GE stock would be valued at $13.21.

With a peer level P/E ratio around 21, GE’s stock would be around $17 per share, but currently its P/E is 28. Honeywell's P/E is 22, Berkshire Hathaway's P/E is 21.32

GE has some valuable assets but its margins have declined due to high expenses. The new CEO John L. Flannery has vowed to turn around the company.

The Wall Street Journal reported that GE used a two-jet flight system for flying its former CEO Jeff Immelt. That is a complete waste of money. The new CEO has grounded the two plane system. GE executives did not notify the board about the practice of trailing the former CEO with a spare jet anytime he traveled. Management for years also withheld from directors an internal complaint it received about the empty plane.

Morgan Stanley and UBS reduced their ratings for General Electric shares due to concerns about dividend cuts at its Nov. 13 analyst meeting, CNBC reported. Morgan Stanley believes the dividend cut is not priced in. “We believe investors need to take action to protect against the possibility of near term under performance in the event of a dividend cut in November and this is clearly an additional factor in our rating change," Morgan Stanley's analyst writes.

During the financial crisis in 2008-09, GE stock fell from $25 per share to $7 per share. Warren Buffett agreed to lend GE some money. I bought the stock around $22, but later sold it at $9 per share for a big loss. I know some vulture-like investors who bought GE at $7 and $9 per share and held on until the stock got back into the 20s again.

GE has some great assets but will need a massive restructuring in order to pay down debt and improve its capital structure. Asset sales are likely.

Conclusion

Investors looking to buy GE shares may want to wait for the price to fall below $20 per share. I think the company is worth about $13 per share. Because GE is such a well loved company with over a 100-year history, it is likely GE shares won’t remain down for long. We may see a massive downswing and a massive upswing, perhaps back up to $20 within a short time period.

Disclosure: I do not own GE shares but may consider buying GE if the stock falls below $17 per share.