Stocks: General Electric Is Down, But Not Out


General Electric has fallen 73% in a year. Does that share price drop represent the buying opportunity of a lifetime or a bellwether for the eventual collapse of one of the biggest companies in the world?

It's hard to imagine a world without GE (Stock Quote: GE). From appliances to light bulbs to airplane engines, General Electric's products can be found everywhere. But conglomerates, such as GE and Tyco (Stock Quote: TYC), tend to trade at a discount to the sum of their parts. It's almost like owning a mutual fund, management fees and all. Some investors argue it's better to purchase shares of companies operating in single industries. Ratings

With GE, an investor gets more than just the present value of future cash flows from businesses it owns. There is also the security of a strong balance sheet.

But that safety was called into question after Standard & Poor's downgraded GE one notch from its highest rating of "AAA," which the company had held since 1974, to "AA." The result is an increase in debt costs.

The company's diversification, which helps spread risk, hurt GE this time around. GE Capital, its financing arm, has been caught up in the credit crisis. GE's sterling credit rating had allowed the division to expand profits with dirt-cheap financing, making it a cash cow in boom times. With the ratings downgrade, the availability of inexpensive funding will disappear.

The spread between "AA"-rated 5-year corporate bonds over "AAA"-rated debt is 81 basis points. If GE had to refinance its $330 billion in debt today, its after-tax borrowing costs would increase from 4.57% to 5.34%, translating into additional annual expenses of $2.5 billion, or about 25 cents a share. Of course, that debt wouldn't have to be rolled over at once.

Besides, there are only six companies left with "AAA" credit ratings -- Microsoft (Stock Quote: MSFT), Pfizer (Stock Quote: PFE), Johnson & Johnson (Stock Quote: JNJ), Exxon Mobil (Stock Quote: XOM), Berkshire Hathaway (Stock Quote: BRK.A) and Automatic Data Processing (Stock Quote: ADP).

GE has a "hold" rating from ratings. Our model downgraded GE while it was still above $30, avoiding the slide to $6 earlier this month.

During the longest recession since the Great Depression, GE has increased revenue, and its gross margin has only narrowed four percentage points. When the financial system seemed to be on the brink of collapse, General Electric produced a return on equity of 15.7% at the end of 2008, 3.75 percntage points less than a year earlier.

As the economy rebounds in the coming months, GE will capitalize on demand for equipment, and its financing unit will be more than able to provide cash-strapped customers with the means necessary to buy this gear.

The movement from "AAA" to "AA" is hardly cause for alarm. While the increased risk is going to raise financing costs and hold back the stock price, there is nothing to suggest GE could cease to exist anytime soon. At its current price of about $10 and with a dividend yield of more than 11% last year, investing in GE doesn't entail a lot of risk for most long-term investors. Even with the recent dividend cut to 4%, the yield is still attractive, given the current rates on "risk-free" securities such as Treasury bills.

Editor's note: In response to the turbulent economy, Ratings has introduced "Is It Safe?", a series that analyzes the risks of stocks, funds, commodities and other potential investments.

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