By Rachel Layne and Edmond Lococo
March 24 (Bloomberg) -- General Electric Co.’s jet engine, power-plant turbine and medical equipment businesses need to ensure they generate the cash flow that underpins GE’s freshly upgraded “stable” outlook from debt-rating services.
“The concern going forward is going to shift back to the infrastructure and transportation side of the business,” said Peter Sorrentino, who helps manage $13.3 billion at Huntington Asset Advisors in Cincinnati, including 6.4 million shares of GE. “The industrial side of GE needs to see the recession begin to abate no later than the fourth quarter of this year.”
Moody’s Investors Service cut its ratings for long-term debt of Fairfield, Connecticut-based GE and the GE Capital finance arm yesterday by two levels to Aa2, stripping away the top Aaa rating for the first time since 1967. The outlook was listed as “stable” in part on GE’s $121 billion service- contract backlog, Richard Lane, the Moody’s analyst who follows the parent company, said in an interview. The service orders are part of a $172 billion total backlog that includes equipment.
“They’ve got a huge installed base of a variety of types of equipment worldwide” that needs to be serviced, Lane said. The long-term service agreements also provide for “baked-in” price increases, he said.
The cut by Moody’s is one level deeper than a March 12 downgrade by Standard & Poor’s and like S&P carries a “stable” outlook, comforting investors concerned about a deeper reduction. GE shares and bonds rose yesterday.
GE climbed 89 cents, or 9.3 percent, to $10.43 yesterday in New York Stock Exchange composite trading, as stocks advanced worldwide on speculation the Obama administration’s plan to rid banks of toxic assets will spur growth.
Equipment Contracts
GE is the world’s biggest maker of power-plant turbines, jet engines, medical imaging equipment and locomotives, and it also includes NBC Universal among its non-finance businesses. Other areas include security and water treatment.
The company’s shares dropped 72 percent in the past 12 months as investors speculated the finance arm would need more outside funding or was harboring undisclosed losses. GE Capital’s businesses span credit cards, real estate, corporate lending, and leasing for equipment such as planes and railcars.
The finance arm won’t need more outside funding and will at least break even this year under scenarios the Federal Reserve is using to test banks, GE executives including Chief Financial Officer Keith Sherin told investors during a six-hour meeting in New York last week. In October GE sold $3 billion in preferred shares to investor Warren Buffett’s Berkshire Hathaway Inc. and and $12 billion in common shares.
GE, which stopped giving per-share forecasts this year, in December said it had a “framework” to produce $5 billion in profit this year at the finance unit and for profit at the non- finance businesses to be little-changed to up as much as 5 percent.
GE Capital Profit
As the economy slows, so does the profit from the industrial divisions as fewer orders are made. That could be made up in part by cost cuts GE is undertaking, the Moody’s analysts said. Though a protracted economic slowdown and tight credit markets may create “headwinds,” the Moody’s analysts said the industrial contracts provide the visibility GE needed to move to a “stable” designation.
GE is also cutting costs and since 2007 has eliminated 20,000 to 25,000 positions at GE Capital, executives said last week. GE Capital had about 73,000 employees as of Dec. 31. Industrial units are also looking at ways to generate more cash.
“We’re in a tough economy, and the company’s going to reflect that in its operations, but we’re focused on taking costs out,” Sherin told investors last week. “We’re focused on running the company to make sure we generate the cash flow we need, and we’re still investing in the long term. We’ve got a lot of investments going on in new product introductions across the industrial portfolio.”
Cash Flow
Moody’s actions presume GE’s non-finance areas will generate $2 billion to $3 billion of free cash flow in 2009 after the dividend is paid, and more in subsequent years. That rise reflects GE’s first cut in the shareholder dividend since 1938, expected to save $9 billion annually, the analysts said in their statement. That cash could be used to support GE Capital should the need arise.
Services last year represented 31 percent of non-finance revenue, up from 20 percent in the mid-1990s, Moody’s said. The service-related revenue at GE is tied in part to more than 3,500 gas and steam turbines and 9,000 engines for commercial and military aircraft. The rest is gleaned from medical, oil and gas and transportation products including locomotives.
“The focus now is on them running their businesses,” said Malcolm Polley, president and chief investment officer at Indiana, Pennsylvania-based Stewart Capital Advisors LLC, which manages about $1 billion, including 209,677 shares of GE.
“Now people can stop looking at the potential crisis in the finance business and look at the actual businesses inside the GE umbrella,” Polley said.
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