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GE: Still a Strong Buy, Despite Downgrade

April 20, 2012 | About:
In early April, Moody’s downgraded the debt rating of General Electric (GE) from Aa2 to Aa3. They also downloaded the conglomerate’s finance unit, GE Capital, from an Aa2 to an A1. These downgrades reflect the risks associated with GE Capital’s funding model. Although GE’s liquidity and capital levels had improved since the credit crisis, they have not improved enough to save the firm from a downgrade. Should this affect your decision to buy GE? I say no.

According to Russell Solomon, Moody’s senior vice president, the risks at GE Capital were significant enough to affect the rating of GE itself. Any implied risk related to the firm’s industrial business lines was not taken into consideration for the downgrade. Also not affecting the downgrade was GE’s credit position, which according to GE spokesman Andrew Williams is still very strong.

Williams also pointed out that GE Capital is one of the highest rated financial services companies worldwide. With an admirable balance sheet and over $80 billion in cash, it is hard to disagree.

Since the credit crisis, Moody’s was forced to revise their global rating methodologies for finance companies. Had this revision not occurred, the downgrade would most likely never have occurred. Additionally, GE Capital’s aforementioned funding model risks would never have been noticed.

With so many other divisions under its umbrella, I do not expect GE Capital to affect the overall value of GE itself.

Energy

While GE Capital threatens GE’s credit rating, GE Energy — the energy infrastructure division of GE — is hoping to make up for any negative impressions. The division recently revealed some new products which should boost sales and impress shareholders as well.

One of the new products being unveiled is an excavator solution. This may sound foreign to you, but to miners, it means more efficient mineral mining than technology currently offers. Another emerging energy product is GE’s new bus protection system. If you are not an electrician, this will sound Greek to you. If you are, however, you will be lucky enough to understand that the new system decreases the effort, time and cost of required field wiring for bus protection applications. In short, it will take the load off of utilities by allowing primary equipment suppliers to install, design and commission field wiring for new installations.

GE Energy comprises almost 30% of GE’s stock value. The innovative division sells both to individual consumers and to businesses. That is not to say they lack competition, though, including companies such as 3M, Johnson and Johnson, United Technologies Corporation and Citigroup.

Competition

Although the products that 3M (MMM) offers are household names worldwide (Post-it®, Nexcare™, Scotch®), the company is currently focused on new product invention. It also has strong acquisitions such as Alpha Beta and Winterthur under its belt. However, the new product offerings determine whether or not the growth objectives will be met. If the market fails to accept the new products, if the timing is off, or if the pricing is wrong, the stock will easily see a negative effect.

Complicating issues is the immense pressure staring at 3M from global competitors. In order to survive in countries like India and China, the company will have to work locally: developing, manufacturing and hiring within the countries of competition. This should be a challenge. I do not see 3M as strong enough competition to threaten GE.

Another competitor of GE is Johnson & Johnson (JNJ). Although its main focus is healthcare, they too are diversified. And to the liking of GE shareholders, JNJ had a challenging fourth quarter. Several product recalls complicated the fact that its profits were barely existent.

However, JNJ has popular brand names for ammunition. It is unlikely that they will suffer for long, keeping them in the running with GE, but not as strong.

Have you ever heard of fuel cells? You have a couple decades to become familiar since that is most likely how long it will take for the technology to become popular. In the meantime, however, fuel cell technology promises hyper-efficient energy sources. Both GE and UTX are in the market to compete with FuelCell Energy (FCEL) which now dominates the market. In GE’s corner is the fact that they are a stronger contender with a larger focus on alternative energy with financial resources to boot.

Another competitor of GE’s is Citigroup (C) which also happens to be in review for a possible downgrade thanks a $1 billion lawsuit filed by the SEC. The suit claims that the company misled its investors of its $1 billion derivatives deal. Another hurdle facing Citigroup is the fact that a New York City judge rejected the proposed settlement of $258 million. This controversy, coupled with the company’s struggles with the housing market, gave Citigroup an earnings decrease of about 11% in the last quarter of 2011.

Further complicating issues for Citigroup is the European debt crisis. When the crisis worsens, bank stocks fall. If Europe continues on this path, Citibank could be in a sad state, making it no match for GE.

The Bottom Line

GE follows the old adage of “do not put all of your eggs into one basket.” A diversified brand like GE would have to have very fickle foundation in order to belly up. But the stock market likes numbers and if GE Capital fails to get their act together, another downgrade by Moody’s could have investors wondering. I think this is highly unlikely, however, and would still add GE to my portfolio at $20 per share.

About the author:

Dividend King
I am primarily an investor interested in creating passive income streams through dividends. I focus on finding and analyzing dividend paying stocks, MLPs and REITs that are a good fit for income investors.

I practice Judaism and my faith is very important to me. I visit family in Israel once a year, but I am educated and work in the United States where I hold an MBA and a bachelor’s in English. I am a patient man, enjoy wine but am not a connoisseur, and I listen more than I speak.

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