Is GE A Bargain Or A Trap?

As GE leads the financial sector lower, the question remains, SHOULD GE be leading the financial sector lower!?

There are no two bits about it, General Electric is way off its highs. Perhaps we can admit that much of the selloff was for good reasons. Heck, we can fairly classify the company as a sub-$15 equity holding in this environment. But is GE under $10 a case of severe pessimism that should be largely regarded as a buying opportunity and a blessed valuation from a pained market? Or are we simply facing yet another value trap?

To answer this, let's look at the short- and long-term prospects of holding GE.

The Bulls' Case

The only problem with General Electric in this market is that it has lost some of its "street cred" by moving 40% of its revenue stream toward GE Capital. In fact, if we wanted to value the entire unit at $0, we should still reach an intrinsic valuation above $8 a share.

But first things first: Is GE Capital really in such bad shape? After all, the unit made a hefty $8.6 billion in 2008 and is projected to pull in another $5 billion in 2009, even in this environment. Most of their assets are long-term regardless ... so should we really hold the company to the same standards that we do Citigroup (C) ?

Management under CEO Jeffrey Immelt should be considered a driving factor for holding the firm above the puny 4.0 times price-to-earnings multiple that shares are currently commanding. General Electric has essentially two credit woes that have been highlighted in the news as of late: its dividend and its credit rating. Last week, GE announced a plan to trim its dividend payout to 10 cents a share starting in the third quarter of 2009 (it's the first quarter GE can do this, because of an old dividend plan).

This is a net positive as far as I'm concerned, since it shows that management is more focused on shoring up its books than in appeasing the few shareholders who still regard a dividend payout in high esteem (regardless of the fact that a once-$30 stock is now practically trading on the pink sheets). Additionally, while Moody's has made it clear that GE's AAA credit rating is still under review, a cut to AA wouldn't materially affect the company's debt structure, because this is where GE's unsecured debt issues has already been priced.

Because GE is on pace to alleviate its bad-asset exposure over time, with a long-term financial restructuring plan that seems to be well on track, should investors not be turned to the future? With more than half of its bookings coming from industrial companies, where there is a backlog of $51 billion in equipment and $121 billion in service agreements, General Electric is making money. Furthermore, President Obama's stimulus plan could lead much of GE's "Ecomagination" unit in particular to big jumps in profit, as the energy-efficient focus will drive revenue through Obama's electric grid, among other projects.

Under $10? Let's get serious. Unlike the banks that GE trades with, it is making billions in profit every quarter ... and this train shows no signs of slowing. Clearly, there is a disconnect between reality and trading activity. Buy GE.

The Bears' Case

Does it really matter what General Electric does anymore? The answer: probably not. Investors in this environment are taking extremely bearish positions on shares of GE. As we discussed options trading above, it is clear that many investors are willing to take bets to drag shares lower on speculation. No longer does it matter where long-term investors price GE's assets, because we seem to be experiencing a virtual "run on the bank" for a company that has too much financial leverage for its own good.

On the one hand, General Electric is making strides to shore up its balance sheet. However, let's consider that the strategy includes restructuring much of their debt in such a way that has them promising $133 billion of debt maturities coming due in 2009. Additionally, while General Electric's fourth-quarter conference call marked leverage ratios at 7:1, with a targeted 6:1 by the end of the first quarter 2009, we can have a look at its long-term debt position of roughly $523 billion and call out a leverage number closer to 60:1. And sure, GE has reduced its exposure to commercial paper, but it still has around $70 billion lurking on its books.

The problem of trust is yet another issue. A large disconnect between what Immelt asserts and what GE's actions later yield is becoming almost too much to bear. Example one lies in the company's assertion that the dividend was "safe," until it ended up announcing plans to eliminate most of the yield one month later.

The problem many investors have with GE is that nobody knows when the bad news is fully out and accounted for. After issuing profit warnings two times between its third and fourth quarter, it still missed consensus estimates in its most recent report. Moreover, General Electric has very suspect markings for "goodwill" and other intangible assets that far outweigh tangible items. Finally, a dangerous exposure to financing in Eastern Europe could very much blow up in GE's face, and it would lose much of its receivable bookings on potential defaults.

Under $10? Don't be surprised. The fact that GE's financial unit is still largely an enigma to accountants around the world, and the fact that traders have a vice-grip on this company's shares (intent to sell them lower), leads me to believe this firm still merits a short position. Sell GE.

The Victor?

I am under the conviction that while shares of General Electric are highly susceptible to a bear market bounce, we will see the company consolidate to the downside over the next month. When hedge funds and leveraged short-sellers are pouring capital into this downward-momentum trade, it is tough to bite the bullet and begin building up a long position. However, I remain convinced that this all-American conglomerate will see recovery starting in the second half of 2009.

The victor may be different, depending on whether you take a short or long term view on investing in the stock. For the short term, GE is more than likely going to continue its volatile path; however, I would be cautiously building up a holding in General Electric anywhere under $10 a share, and adding on the way down for longer-term success.