5 Takeaways From General Electric Company's Annual Report

Here's what I learned reading GE's annual report.

Mar 20, 2014 at 6:05PM

Each year I look forward to the release of General Electric's annual report. GE's one of my largest holdings, and I'm always eager to learn something new about this vast and complex company that I didn't already know.

This year, I can rest assured Warren Buffett's reading it right alongside me. His holding company, Berkshire Hathaway, increased its position in the industrial company substantially last quarter.

With that in mind, I thought I'd share with investors -- including the Oracle -- a list of the top five things I learned from reading GE's annual filing.

Ge Logo

Source: Wikipedia.

1. GE's financial position is getting stronger.
GE leads all U.S. companies in debt coming due this year, but the industrial giant is not fretting over these long-term-debt maturities of $39.2 billion. Most of this is GE Capital debt, and the financial unit can borrow an additional $47.8 billion through 50 banks as needed to extend or refinance. Further, GE Capital holds $75 billion in cash while the parent holds an additional $14 billion.

GE Capital also disclosed an 11.2% Tier 1 capital ratio, which is a metric used by the Fed to gauge a bank's capital strength. This figure exceeds the fourth-quarter Tier 1 ratios posted by every other major bank in America.

2. Only the Middle East and Africa region is growing impressively.
While GE boasts that its sales in 24 countries independently eclipsed the $1 billion mark, the only region that posted healthy sales revenue growth in 2013 was the Middle East and Africa. This uptick stems from energy investments in Africa, a continent the company claims is growing at a 30% annual clip.

Combined sales in the U.S., Europe, Pacific Basin, and Americas regions declined 1% year over year.

3. It's still not paying much in taxes.
For a company trying to redeem its tarnished tax reputation, GE sure isn't doing much in the way of paying those pesky income taxes. Of course, GE's accountants are playing by the book, but it just so happens that the complex tax code, GE's overseas subsidiaries, and GE's non-repatriated income work to reduce the bill substantially. GE's income tax rate dropped into the single digits in 2013:

 

2013

2012

2011

Income tax rate

4.2%

14.6%

28.5%

In a nutshell, GE benefits from global operations that are not subject to U.S. tax rates because their earnings are "indefinitely reinvested" outside the U.S. The taxes in those countries are much lower than the 35% U.S. statutory rate, so GE avoids a hefty tax bill on that income. Fifty-three percent of GE's total revenue comes from international operations, but it does not separately disclose income amounts.

4. It closed its pension's funding gap substantially.
GE, a company with 620,000 current and retired employees covered by pension plans, benefited from soaring asset prices and higher discount rates in 2013. These two factors converged to substantially reduce the underfunded status of GE's primary plan.

($USD in billions)

2013

2012

2011

GE Pension Plan underfunded amount

$4.7

$13.3

$13.2

The discount rate used by the company to project obligations increased in 2013, which reduces the net present value of these future liabilities. This, combined with strong asset returns of 14.6%, helped shrink the underfunding gap by a total of $8.6 billion from 2012 to 2013, as shown above.

Looking ahead, GE's benefit plan costs are expected to decrease to $1.3 billion in 2014 compared to $6 billion in 2013. They were $5.5 billion in 2012.

Shareholders should take this news with a grain of salt since rates, investment returns, and regulatory changes can cause the funding status to swing from one year to the next. For now, however, it's a positive trend in an area I considered one of GE's most significant risks.

5. Its core business is a razor-and-blade model.
It wasn't as clear to me until I isolated GE's industrial segments, but its core business model is like the classic Gillette razor-and-blade combo: low-margin equipment sales spur follow-on higher margin sales of services.

In 2013, excluding GE Capital, 71% of GE's revenue came from the sale of equipment that generates a run-of-the-mill 22% gross margin. On the flip side, 29% of sales were attributable to services that produce hearty 36% gross margins.

GE would prefer the juicier margins, of course, but the two businesses go hand in hand. Sales of engines, turbines, and all sorts of other machines lead to an ongoing relationship since customers require replacement parts, repair services, and maintenance. That relationship lasts for the length of the equipment's useful life, which could be years or decades. That's why GE's $244 billion backlog is made up of $180 billion in services and only $64 billion in equipment.

All told, 2013 was a solid year for GE. Shareholders should be pleased that the company's making progress on downsizing the financial business, which will soon be overshadowed by GE's industrial earnings. For additional reading, check out my insights into GE's shareholder letter or download the annual report.

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Genx

GE's GEnx engine. Source: General Electric.

Isaac Pino, CPA, owns shares of General Electric Company. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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