Back in 2007, when analysts talked about gushing profits at the conglomerate General Electric (NYSE: GE ) , they were talking -- primarily -- about its ballooning banking business. Fast-forward to today, and GE Capital's balloon is slowly, but surely, deflating.
GE's latest fourth-quarter report confirms that the banking arm is gradually withering, contributing a smaller portion of revenue and assets at GE. Two charts illustrate why this soft landing could be a win-win scenario for shareholders.
A smaller, more satisfying slice of the pie
Before delving into the so-far successful turnaround of GE Capital, it's important to keep a couple key plot points in mind:
1. GE Capital's heft before the financial meltdown was completely unnecessary. While lending can be a tangentially related endeavor for a manufacturing company, GE management readily admits that the profits in banking were ultimately a distraction from the core business.
2. GE Capital's turnaround required a helping hand. In 2009, legendary investor Warren Buffett stepped in to back General Electric with a $3 billion loan to a company he called "the symbol of American business to the world." Buffett's endorsement helped GE regain its credibility and footing. While GE avoided TARP, the company benefited from stimulus and financial stability programs available to many of its peers.
There's no debating that GE drove itself into a ditch with a highly leveraged bet on banking, and the company needed a lift to pull itself back on the road. With that in mind, however, investors must look at more recent history to determine whether GE's headed in the right direction. The following chart provides insight into GE Capital's shrinking piece of the revenue pie, and rebounding profit margins.
On the top line, GE Capital has shrunk from 38% of consolidated revenues in 2007 to 31% at the end of 2013. Meanwhile, GE Capital's net income contribution took a nosedive in 2009, but has since recovered to once again make-up about half of the company's total 2013 profits.
While investors might balk at the proportion of profits delivered by GE Capital, GE's on-track to both strengthen and contract the banking business. Increasing profits reflect a healthier operation, while shrinking revenues and assets will diminish GE Capital's importance over time.
GE recently announced plans to spin off the consumer lending business within GE Capital. In a step-by-step fashion, GE appears committed to shedding components of GE Capital, and the consumer loans make-up approximately 18% of total loans.
Further, two other trends predict the fate of GE Capital, where assets and ending net investment have trickled downward in recent years.
The second chart reveals a shrinking GE Capital asset base, which declined by 29% from 2008 to 2013. At the same time, a more revealing measure of the size of GE Capital's business is ending net investment, or ENI. At GE Capital, ENI accounts for the total "capital" -- either debt or equity -- required to fund its loan operations, and by this number GE Capital's contracted by 38% since 2008.
The fate of finance at GE
Following Wall Street's near-implosion, many GE shareholders were more than willing to cut ties with a casino-like lending operation, but a complete spinoff was not in the cards. Instead, GE set forth a plan to rejuvenate the finance business while relegating it to the sidelines.
This was a next-best scenario for shareholders, and the industrial and finance businesses appear stronger today as a result. As illustrated in the preceding charts, GE Capital carries less weight when it comes to key metrics like revenue, assets, and ending net investment. Each one tells a story of a business segment in decline, but one that continues to bolster profits for shareholders all the same.
Why Buffett backed GE
As he noted in 2008, Buffett believed GE's "strong global brands and businesses" would allow the company to bounce back after hitting a wall. In other words, Buffett backed GE for the same reason he's invested in numerous multi-bagger companies over the years. To reveal Buffett's most valuable insight, we recently compiled the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.