The Globe and Mail

  GE hopes to live better — and not just electrically


Friday, September 24, 2010

As questions persist on whether or not governments should continue their various stimulus programs, we felt it was time to throw our two cents in. Who would believe?

First, some pundits suggest that stimulation has failed to, how should we put it, "stimulate." They opine that because economies are not booming, the process has been a failure. They ignore the fact that while the global system may not be expanding as fast as their desires, the extraordinary spending assuredly helped narrow the economic trough. That saved the bacon for many who would have been seeking jobs had governments not taken action. These employed people then had greater ability to stoke the financial engine.

While some prognosticators are bullish on economic prospects and doubt the double-dip scenario, others look at the numbers and posit deep fears for the future and wave the big "OH-OH" flag. But a decline was to be expected. When the government and corporations offered incentives and tax breaks to buy, they stole from sales tomorrow. This is not necessarily a policy bereft of wisdom. A smoothing of the economic cycle to avoid even deeper recessions or a depression can make tremendous sense, but one must recognize that Paul is being robbed in the future to pay Peter now.

Major mistakes were made previously by both the U.S. and Canadian governments when the economy was pushing ahead tickety-boo. Cutting taxes, which further heated an already hot economy, was stupid, especially since it stopped governments from harvesting surpluses to pay down debts when times were good. Instead, it simply caused deficits and additional debt, leaving less in the governmental tank to fight off the bad times which inevitably occur. Adding further stimulus now could put us in the same trap as Japan, wracking up debts on a geometric curve, just to tread water.

One of our purchases with a view of the macro situation was General Electric at $15.56 in December of 2009. This corporate behemoth is a cross-section of the economy with divisions involved in energy, financial, media, military and technology, to name only some. When the economic meltdown occurred, GE suffered tremendously and the share price dropped under $7.00 (U.S.) from the high $30s only a year before.

Unfortunately, this purchase was a bit late to the dance. However, the feeling was that there was lots of upside to come, both as the economy recovered and the dividend cut was gradually reversed. That is already underway, with a recent 20 percent increase to 12 cents (U.S.) a share. Not many companies can brag that they have paid dividends for two centuries. That was even before Ronald Reagan started telling people to live better electrically!

While GE was indeed hammered during the global meltdown, with its profit falling by more than half from two years previous, the net income still chipped in at about $11 billion. In the most recent quarter, revenues were $37.4 billion and earnings $3.3 billion, which equates to 30 cents (U.S.) per share. The backlog has nicely increased and the company feels that GE Capital's earnings are rebounding and losses will trend downwards.

The balance sheet remains sane and in fact is arguably better than a few years ago. Certainly though, deals such as the one done with Warren Buffett in late 2008, where he bought $3 billion of preferred shares with an interest rate of 10 percent, plus warrants to buy $3 billion worth of shares at $22.45 through 2013, are costly longer term. Plus, GE had repurchased $27 billion of shares in the three years preceding this deal at an average price of $36. That can best be described as foolish, as share buybacks at historically high prices often prove to be.

Still, General Electric is a lovely complement to many of the smaller names in the Contra portfolios. It is on the buy list with a target price of $35.24, a bit better than double the current level of around $16.50 (U.S.). While waiting hopefully for that valuation to occur, the dividend around 3 percent will have to suffice.