Gudovac always gets a pleasure from hearing polished Managers presenting quarterly results. These presentations can lull even the most jaded owner into a benign torpor. That Middle American quiet confidence. The array of perfectedly composed charts. The team spirit. The situation at the enterprise in question is always the very model of a modern major
Therefore, one should treat any GE presentation as one would a lush summer pitcher of Gimlets - Enjoyable for certain, but don't even think of driving until the next morning.
Gudovac had a good night's sleep and then looked at the numbers.
The industrial side is working through orders booked during the heady days of late 2007 and early 2008. One would expect that margins on these orders to be extremely healthy. They are. The operating margins are up in the key part of this group by 13 points. However, one can also expect that margins going forward will have steep downward trend. In 9-24 months we can expect Industrial margins to approach zero in some divisions.
GE's managers enjoy talking about their service business. It will continue to provide the cash flow and margins necessary to prop up the industrial side of the Enterprise. Senior Management will press service to make up the shortfall in new equipment. Owner's can therefore expect overall operating margins to remain postive throughout the down cycle.
Now on to the capital side of the Enterprise.
The capital side of the enterprise is simply a train wreck. Owners will look forward to 28.July when managment presents more details. The information presented yesterday was not reassuring at all.
Non-earning 'assets' are approaching mind boggling levels. The projected recovery rates are, at first blush, childishly optimistic. 75% LTV ratios may be prudent in a normal post-war recession. However, today's depression will see 50% drop in overall Real Estate prices in Anglo-Saxon economies. Industrial and Commercial properties may even experience more than 50% decrease in valuations. Management's reserves are woefully inadequate to address these levels of assets impairment.
Gudovac will wait until the 28.July detail to fully quantify what might be an appropriate reserve level. A back of the envelope calculation suggests that reserves for non-earning 'assets' are between 1/2 and 1/3 lower than necessary.
Owner's should understand that middle market industrial and commercial companies only went to GE Capital if they couldn't get financing at Commercial Banks. This suggests that some of GE's middle market lending may have been to weaker companies. GE's good sense to always be in a senior secured position with this market will buttress recoveries. However, when liquidation values are dropping 50% or more, even GE's most assertive recovery methods will not make owners whole.
Finally, Owners need to examine how much financing GE is providing for its own customers on the industrial side. Gudovac expects to have this question answered on 28. July.
At $6 a share, GE is priced at over $500 billion of Enterprise Value.
At $6 a share, GE pays a good dividend of 6.6%
At $6 a share, GE is priced at over 15x TTM EBITDA
At $6 a share GE is priced at over 3x Revenues
A $6 share value for GE implies supreme confidence in GE's management. Gudovac would only value an enterprise at such high multiples if he believed that management is first rate.
Don't Get Massacred !
Gudovac1941@gmail.com
Do you really think GE is doomed ?
ReplyDeleteFrom an Reader's Email
ReplyDelete"......Gudovac,
I enjoy the whole deal you have going on at Gudavoc1941. You do a good job of shrouding yourself in relative mysteriousness, while getting just specific enough to claim victory; even if the net is of a relatively wide nature. The criticism of management is a great touch too.
The main purpose of this email though, is to ask you: what is so bad about GE's "book"? It's all right to say that other financial institutions are afflicted by the same woes, I just was interested to hear what exactly those woes were, in your opinion........."
Gudovac responds:
GE's accounting is suspected by many to be packed with hidden reserves, off balance sheet items, hail mary estimates, and just general manipulation.
1st - The pressure for managers to make-their-numbers during the Jack Welch era was simply enormous.
2nd - A rock solid line of growth (for decades) at any enterprise is simply impossible. GE until 18 months ago, had a steady slope of earnings growth matched only by Bernie Madoff.
3rd - Persistent rumours in the manufacturing industry arose during 2001 -2004 that orders were given to GE managers with P&L responsibility to clean up the books. These ranged from specific cases told to me by (low level) GE guys to more substantial stories.
4th - My own experience. I never worked for GE, but competed with them in a core business for them for more than a decade. The GE guys I competed with were decent managers but not great. GE managers are a far cry from Toyota.
Don't Get Massacred !
Gudovac1941@gmail.com
.......Gudovac,
ReplyDeleteThanks for the response.
Yea, I would agree with the gist of your assessment; furthermore, I
think your stated price range is reasonably accurate.
At this point though, I don't think the market is focusing so much on reported earnings - or even EBITDA/enterprise for that matter. As long as GE's cash flow appears sufficient to maintain the dividend at current
levels, the stock should stabilize at current levels. The lower it
goes, assuming we don't near a collapse of the entire system, the
better a buying point it will be.
Of course, this is simply my opinion, and shouldn't be construed as a
recomendation to purchase any security. You probably know that though.
Enjoy your blog man, keep it up.........."
Gudovac's thoughts:
The reader is likely correct: ".....As long as GE's cash flow appears sufficient to maintain the dividend at current levels, the stock should stabilize at current levels......"
However, a 3% or 4% yield is not enough to buy GE.
Gudovac feels more comfortable with yields north of 5% for ur-mature companies. Gudovac's gut sense is that he needs a premium on top of his 5% threshold to account for the risks of GE Capital as well as the risks associated with the poor quality of the financial reports.
It will be years before GE is a darling of speculators again - due to uncertainty w/ GE Capital.
Finally, Buffet thought GE needed a 10% dividend to justify his risk - why would anyone buy with a 4% dividend ?
At $6 a share, the 40 cent dividend provides a mere 6.6% yield.