General Electric is an industrial conglomerate, originally founded by Thomas Edison in the 1800’s. It has changed form in significant ways since its founding, and now has business lines in healthcare, energy, airplane engines, and more.
Hey, what’s up y’all today we are going to tackle the first company in our s&p 500 series. It’s a large industrial company and you think you might know well, let’s check it out. Welcome to Stock stories, Episode Six.
Yeah, all right. So thank you for joining me today. Really appreciate you listening. Again, this is stock stories. I am your host, Alex. This is a podcast dedicated to helping you understand individual companies so that you can make better investing decisions. That’s what this is all about. And I’m really excited today because we have our first company to analyze layout. This is a big deal. The first five episodes have been focused on the framework and kind of the philosophy behind investing. We’ve talked about what is the anatomy of a company, the history of stocks, we’ve talked about the whole investment universe. And now we’re at the point where, you know, I think we should really get into analyzing a specific company. I’ve been telling you guys this for five episodes now. So thanks for sticking with me until this point. So what is the first company that we’re going to talk about today? Well, it’s one of the most famous companies in the world. It is General Electric. This is the big industrial company that everyone knows about. And today, we’re going to talk about it. So without further ado, welcome to stock stories. And today, let’s talk about General Electric.
History of General Electric
So let’s talk a little bit first about the history of General Electric, to see where it comes from. Because I believe in order to understand a company’s present prospects and its future prospects, it’s a good idea to at least have a little bit of context as to where it came from. So what’s the history of this business? So General Electric, was founded by none other than the famous Thomas Alva Edison, the man who brought electricity to the masses here in the United States.
So Edison created a company called Edison General Electric Light Company, in 1889. This is an old company hails back to the 1800s. And it was funded by none other than JP Morgan himself, as well as the Vanderbilt family. So these two financiers got together, saw what Edison was doing, and decided to invest in his lighting company. So this company merged in at 92, with the Thomas Houston electric company to become General Electric. And so General Electric at this point, started adding consumer products, he started making appliances in the early 1900s, all the way since 1905.
They have been making appliances, so they’ve got lights, and they’ve got appliances. So they focused on those products, first lights, light fixtures, they got into motors and other electric products. They also got into radio and television in the 1920s when these technologies were starting to become more prevalent. Television was still not a staple of American life, not even close yet. It was just in its infancy.
And radio had just started to spread countrywide. So General Electric was on the leading edge of these technologies as they were coming up. General Electric also developed aircraft superchargers for World War One and they developed the nation’s first jet engine in World War Two. So pretty much anywhere where America needed the latest newest technology, General Electric has been there for its development and creating those products and becoming a leader in those products.
Now, there’s a lot more history to this company. But I want to fast forward a little bit so we can get to some of the more recent developments back in 2002. You may remember a company called Enron. And this was an energy company that went bankrupt. They had some trouble with illegal practices. And it shocked investors and it shocks people in the finance community worldwide. But when this happened, General Electric saw some of Enron’s energy assets. And they said, Hey, let’s get into wind power, let’s get into renewable energy, this is going to be the thing of the future. So they scooped up some of Enron’s energy assets back in oh two and got into wind power that way.
So over the years, General Electric has been changing, they’ve been getting in and out of different businesses. So it’s not just aircraft engines, or lighting products, or renewable energy in back in the 60s, they started developing their own computers. And they were actually the first business in the world to own a computer. Think about that, that’s, that’s pretty cool. They were on the leading edge of technology, from way back in the 1800s, through the 20s, through the 60s, into Oh, two, they were getting into renewable energy before. It started to become cool and hit for large companies to get into energy efficiency, they were already thinking about these things. And over the years, they’ve been in a bunch of other different industries.
They have been in plastics, markets and life insurance products. They’ve been in the water, business, oil and gas. And actually, recently, a few years ago, in 2015, they actually sold their appliance division to the Chinese conglomerate higher. And so any GE appliances that you’re aware of, now, if you go and buy a GE appliance, GE doesn’t actually make that it’s another company that has purchased the right to use the GE brand name. So kind of an interesting tidbit. Because I feel like as consumers, at least here in America, we see GE as Oh, yeah, GE Appliances. That’s one of the things that’s top of mind for us when it comes to talking about and thinking about GE products. So GE doesn’t even make his own appliances anymore. So that’s a little bit of the history.
- But where are we at today? What is General Electric the business doing right now. So in order to do this, I had to look into the annual report. And the most recent one is from 2017. And this is what General Electric does now. So they’ve got a total of eight different business segments. This is a big conglomerate, they do all sorts of things. So these are the segments, aviation, healthcare, transportation, capital, oil and gas, lighting, renewables and power. Now those last for oil and gas, lighting, renewables and power, the way I kind of think about it, I kind of grouped them into one super segment of energy, because they’re all related to energy.
- They’re just applying them in different ways. And then the other ones are definitely distinct categories. To me like transportation, aviation, healthcare are definitely its own categories. And capital is certainly its own category as well. It’s, in fact, something that we’ll definitely talk about later, as far as how it affects General Electric’s most recent results. So where are we at now? And I’ll summarize it by a quote from GES CEO, John Flannery. In your report, he says, quote, 2018 is our reset year, end quote.
- And what does that tell you that tells you that? Well, frankly, things have not been going very well for General Electric lately. It’s been facing some issues. And this has been reflected in the stock price as of right now, march 2018. When I’m recording this General Electric stock has declined over 50%. Well over 50% In the past year, it’s just been plummeting compared to the rest of the broader US market, which is done quite well over the past 12 months. So what’s going on? Why is this massive company that is involved in all these segments has all of this history behind it? Why is it struggling right now? Well, we’re gonna take a look. So General Electric.
- As you can see, it’s got a lot of different segments of its business. It is an industrial conglomerate that has a large hand in the globe. economy, General Electric operates in 180 different countries, and it’s got over 313,000 employees. It’s massive. So whenever we analyze any business, we have to look first at what does it do? And where does the cash come from? Right as we’re in the as investors, we want to figure out, where’s the cash come from, so that we can determine if that cash is going to keep coming in the future. And this is going to grow too. So as of 2017 95% of the revenues are coming from industry, and only 5% are coming from the capital division. And that percentage has been decreasing over time.
So let’s break this down into the different segments. So we understand where the revenues and the profits are coming from. So as far as revenue 29% comes from the power division 22%, from aviation 15% from health care 14% from oil and gas, and 8% from renewables, and the transportation and lighting segments. They’re a very small percentage of revenue. And they’re largely insignificant as far as the revenues that they they bring into GE. Unfortunately, those have been declining segments for GE in a very small percentage of the overall cash. Out of all of those segments, the fastest growing one is the renewable segment. So even though it’s a smaller segment at 8% of revenues, is the fastest growing at about 15% annually. So that’s kind of a glimmer of light there, as far as the growth aspect is concerned.
Alright, so revenues are great, but what about the profits? Where did these profits come from? Well, the main segments that bring in the profits for GE, are aviation, and this is of industrial segments, we’ll talk about the capital segments later. So of the industrial segments of GE Aviation brings in the most profits, it brings in 45% of them, healthcare bringing in 23%, and power brings in 19%. So those are the top three profit generators for the company. You got aviation that makes jet engines and other devices for aircraft, you’ve got healthcare, making medical devices, and you’ve got power. So overall, the total industrial profit, it’s $14.7 billion dollars in 2017.
Now that that seems good, like 14 point 7 billion, not too bad. But in 2013, GE made 16 point 2 billion in industrial profits. So over the past several years, the industrial profits have gradually meander down. And when we look at what are the main culprits of this, this trend, why is the industrial profit decreasing? Well, the main culprit is oil and gas is producing just 1/10 of the profits that it did back in 2013. And the power profits have decreased by 37% in that same timeframe.
So oil and gas and power as different segments have decreased in the profits they provided to ge. So we have to keep this in mind that there are many cyclical elements here were in the down part of the cycle as far as oil and gas is concerned. And oil prices just aren’t as high as they used to be. Not to mention that GE just completed a really large acquisition of the oil and gas company, Baker Hughes, which created a new publicly traded company called Baker Hughes GE company, and General Electric owns, I think, a 70 or 65% controlling stake of that company.
So they have made a big investment into oil and gas at a time when oil and gas prices are not that high. And that segment is not that profitable. So that’s the main culprit of why the overall industrial profits have decreased. So it’s not just that the industrial profit has fallen, the capital segment has been wiping away all of the profits and then some. So these capital profits have turned the losses and that really sucks. So GE is in this transitional point right now where it’s it’s been known as a strong industrial company, a stalwart, but it now has these more cyclical elements because of its power in oil and gas divisions. And it’s also kind of a turn around because it’s facing a lot of issues right now, especially with GE Capital.
So when I put General Electric into a category of a stock, as we talked about a couple episodes ago, I think of it mostly as a stalwart, because it does have that over 125 year history, I think, at this point. And it’s been a big part of the American industrial economy for a long time. But I also see it as a cyclical, it’s, it’s going through some ebbs and flows, the Baker Hughes acquisition, as has been kind of frustrating in some ways. And it’s definitely a turn around right now, as well, it, it’s struggling to find its new identity as an industrial conglomerate. So those are some of the things that I think about, even though the industrial profit has decreased a little bit, it’s mainly been hurt by its capital segment and the losses associated with that. So in 2017, General Electric lost $6 billion on the books. And if we look back to 2013, it was in the black at $13 billion. So this is a big difference. This is mainly due to the capital. So it lost $6.7 billion in 2017, from the capital losses.
And if you add to that, a loss of $13.8 billion, you have significant losses. And that’s where we get that 6 billion total loss from because the industrial segments made profit, the capital segment basically took the profit back to zero. Or sorry, the financial charges, charges basically took the profit back to zero. And then the capital losses, put GE back into the red of 6 billion. So let’s dig a little bit more into how is GE Capital losing money? What’s going on here? So after some investigation, I found out that GE Capital owns an insurance company.
It’s called North American life and health. And this is an insurance subsidiary. That works just like other insurance companies, they take in premiums to insure customers against risk. And then they pay out claims, and then the difference between the premiums and the payouts is called the float. And the insurance company uses that float to generate investment income. And that’s basically how insurance companies work. And the very, very short synopsis. So GE Capital has this North American life and health as a subsidiary. So when they’re going through the books, they realize last year that they needed to revise their assumptions, because when you take in money for premiums and insurance company, you need to assume okay, how long am I going to have this money for what’s the amount of interest I can probably generate?
And then based on the timing of the cash flows between the premium payments and the claim payments, you can figure out actuarially, how much profit, you’ll probably make, as well as how much reserves you need to put away to prepare for future payouts that you’re assuming. And that last point is where GE Capital messed up, they realized that they needed to revise their assumptions related to the money needed to be set aside. So GE Capital set up sorry, guys, we actually need to set aside $15 billion for the next seven years as reserves for this insurance subsidiary. And in 2018, this year, they’re planning to put away 3.5 billion, and then from 2019, they’re after $2 billion each year, until they hit that 15 billion.
So that’s where a lot of money is gonna go in the next several years for GE. And I think GE is doing the prudent thing here by recognizing this. It just comes at a really bad time when the industrial profits are not as great as they used to be. And there are also other things that are changing in a big way within the company. So it just one hit after another pretty much all within a year’s timeframe that GE is experiencing. So what is something else that’s going wrong?
So I mentioned earlier, there’s GE Capital, that lost money, but there’s also quote unquote, financial charges that are putting the company in the red. And like I said, they pretty much wiped out the industrial profits that GE had made in 2017. So what are these so called financial charges? Well, digging through the annual report is what I found. So there’s some charges related to the retirement plans about $2.2 billion. General Electric has a big pension plan that a lot of current retirees and soon to be retirees are going to tap into.
And so there are costs associated with that. There’s power, oil and gas, and corporate have incurred lots of expenses as well. So these, as I mentioned before, power in oil and gas, those are the two segments of GE that are probably experiencing the most change they’re struggling the most right now. Oil and gas is that a little part of the cycle in power is struggling as well. So when it comes to the retirement plans, how well funded are these plans?
Well, according to ERISA, which is the Employee Retirement Insurance Act, or something close to the same as the acronym up, according to those rules, it’s 94% funded, but according to generally accepted accounting principles, which is what the SEC looks at, it’s only 74% funded. So the difference in those numbers is just based on the accounting methodology and the assumptions used for those costs. So not super terrible, but at the same time is not 100% funded. And either way you look at it, and General Electric is going to need to incur some costs to meet those obligations that it’s promised to their employees. Another thing related to these financial charges is the revaluation of deferred taxes. So that’s $2.2 billion.
And, as you may or may not be aware, at the end of 2017, the tax cuts and Jobs Act was passed. And that radically changed tax law in the tax code in the United States. And so many corporations are revising their estimates of how many taxes they will owe from here on forward based on their financial position and the composition of their assets and liabilities. So there’s some charges related to that here. There’s also estimated impact of taxes on foreign earnings. As I mentioned before, GE is an international company, it’s based in the US, but it operates in over 100 countries.
And so it makes money on those countries. When a company in the United States is headquartered in the United States, and it makes money elsewhere in the world, the United States will tax the company for those foreign profits if it brings those profits back to us shores. So General Electric is saying, Hey, we’re estimating $1.2 billion in taxes are going to need to be paid here if we bring some money back. So that’s where some more money is, is leaking out of General Electric’s coffers. So we’ve talked about the industrial profits, we talked about the GE Capital losses, and the financial charges and the taxes. So that’s kind of an income expense view of the company. Let’s look at one of the other important financial statements, which is the balance sheet. So what does General Electric’s asset picture look like?
What its liability picture look like? How much does it own? And how much is it? Oh, and what are the compositions of both of those things? So when I first looked at the balance sheet, I’m just gonna tell you, y’all like, I was like, damn, General Electric has a lot of debt. That’s basically the thing that stands out here. General Electric has borrowed a lot of money over the past several years, and it’s going to owe a lot of money in the future. So in 2018, they’re borrowing $6 million for the pension plan alone.
Like I said, with those retirement costs, they’ve got over 300,000 employees, many of them are entitled to pensions in the future. And based on lower interest rates in the market right now, General Electric has to revise some of those assumptions for how it’s going to be able to meet those obligations. So it’s borrowing money in order to fill that bank so to speak. So what is the total debt burden of General Electric, General Electric owes $134 billion in loans, and $40.8 billion of that is the expected interest that it’s going to have to pay. So let’s look at the timing though.
Because if General Electric were to owe all of that, by next year, that would be a major, major problem. But companies don’t tend to do this. They tend to borrow in chunks and structure their debt so that they can pay it back. Little by little over time, similar to if you bought a car and financed it for a few years. You would just spread out that payment. then over time, so how much is due in the near term how much is due later. So of that General Electric owes $85 billion, spread out through 2022. So in the next five years, that’s about half of the debt is owed in the next five years. So when we look at the balance sheet, you’ll notice it says not just borrowings, but it also say other obligations. So these are other liabilities and contractual payments, that General Electric estimate.
And the way I look at this is, it’s technically not dead. Maybe General Electric owes money on some lease obligations, if it’s leasing property and assign a contract to pay over a certain period of time, etc. That’s just one example. But a lease and a debt. Although the two different things, there’s still obligations of cash flow. So from the individual investor perspective, I’m looking at General Electric and saying, Okay, this company has obligations of cash flow for this much over this period of time. It doesn’t really matter that much to me. If that’s going toward an actual notes, it’s trying to pay back or a lease, it’s still an obligation, although there are some differences there.
So there’s 134 billion in debt, how much is the overall obligations? The overall obligations? Total? $354 billion $354 billion? Yeah, that is a third of a trillion dollars. So that’s a lot a lot a lot of money even for such a big company as General Electric. So again, I looked at Alright, how much of this is due soon? How, how is this debt structured? So through 2023, General Electric owes $173.5 billion of this 354. And, again, that’s about 50 51% of the total. So how is it structured 70. Point 5 billion is due this year in 2018 64. Point 3 billion is due in 2019 2020. And 46. Point 3 billion is due in 2021, and 2022. So that’s $181 billion dollars in the next five years. So this is something to consider when you were looking at a turnaround. It’s absolutely critical to see what are the liabilities and how are they structured, and then what are the assets there as well to back it. If a company is truly going to turn the ship around, it needs to be able to pay for its past mistakes, somehow, some way, maybe a company is borrowing a lot of money, like General Electric is here in this example, or maybe they’re issuing a lot of equity, you’ll see that in a lot of like, say a growth techie type company that might have a cash flow problem, instead of borrowing money, you’ll often see that they’ll issue a lot of shares in their company and dilute the existing owners in order to raise money.
So they’re not borrowing money. It’s not a fixed cost in that sense, but it’s still a cost to the shareholders. Because they’re slicing up the pie of ownership into more slices. So but in this case, General Electric is issuing debt instead. So it’s got 180 $1 billion, and obligations due in the next five years, which is a lot. So that’s the bad part of the balance sheet. What about the good part of the balance sheet?
What about the assets? So in the industrial business? Well, first, let me talk about what is the return on capital? So the return on capital is, if General Electric puts $1 into his business, how many cents is it getting back in profits, and you tend to see with certain types of businesses certain ranges of returns on capital. And return on equity is a closely related concept, which I’ll talk about in another episode. But basically, if you have products with higher margins, then you’re going to be able to get more profit out of every dollar that you invest. If you’re in a very capital intensive business, such as an industrial company like General Electric, you’re not going to be able to extract quite as much profit for the same dollar. So to put this in plain terms, if you’re building aircraft engines, like General Electric is you need to be able to hire the engineers, buy all the equipment, you’re going to need machine shops, you’re going to need to subcontract out a bunch of if your work you need tons of people, tons of equipment, and lots of technology in order to make that happen.
Now, if you’re selling syrup, concentrate like Coca Cola Yeah, you need some of those things. but it’s not nearly as complex of an operation as building an aircraft engine. So for every dollar Coca Cola puts forth, it’s going to get more sense of back for that dollar reinvested in its business compared to something like a General Electric, where if it puts forth $1, it’s still going to make money, but just not as much as, say, a Coca Cola.
And when I say make money, I’m not talking about the absolute profits of the whole enterprise necessarily, because that can vary wildly based on a lot of factors. But in talking about the internal reinvestment in the business itself, from the board of directors like what is the CEO putting money into, and how much are those projects generating for shareholders. So all that background is say General Electric’s return on total capital for its industrial businesses. For the past several years, it’s been about 14 to 15%.
But 2017 was pretty terrible year, it was only 2.7%. So again, 2017, just a rough year, for both industrial businesses in general electric as well as the financial arm, which we’ve already discussed. But over the long term, the good news is that General Electric’s industrial segments, they do make profits, and they do have decent returns on total capital invested over time. So looking at the assets segment of the balance sheet, over a period of years, you can see that consistency generally, although it you know, it will fluctuate depending on good or bad years.