The last few years have been rough for General Electric (NYSE:GE). Some of the industrial conglomerate's pain has been outside of management's control, such as weak end markets in the energy and utility spaces. However, a good portion of the problem was self-inflicted, including a debt-heavy balance sheet. With three CEO changes over the past five years, GE appears to finally be getting back in shape. The next year will be an important one -- especially on the leverage front.
Consequences of the financial crisis
The foundation on which every company is built is its balance sheet. Obviously, companies without any debt don't go bankrupt, but companies with too much debt risk failure when times get tough.
In the run-up to the 2007-2009 recession, GE let its financial arm expand well beyond its original mandate of simply helping customers buy GE products on credit. When the downturn came, the conglomerate was hit hard and, frankly, hasn't really recovered. A string of asset sales, writedowns, and dividend cuts have left GE a shadow of its former self. It is still trying to turn things around. Some badly timed acquisitions didn't help the situation, either. The damage is most visible on the balance sheet today.
At the end of the third quarter of 2019, GE had roughly $75 billion in long-term debt and a debt-to-equity ratio of roughly 1.2. That represents a vast improvement. The company was able to cut its debt by roughly 15% through the first nine months of 2019. Looking back a little further, its debt-to-equity ratio is down from over 2.5 in 2010, so a lot of heavy lifting has been done. But there's still a lot of work ahead when you compare GE to some of its peers. For example, similarly iconic industrial giants Honeywell and Emerson Electric both have debt-to-equity ratios of around 0.15.
What's in store for 2020
That said, GE has some big plans that will unfold over the next year. The biggest and most important is selling a piece of its healthcare division to Danaher for roughly $21 billion. That deal was supposed to close in the fourth quarter of 2019, but as of Jan. 1, 2020, the finalization of the transaction hadn't been announced. GE expects the sale of this division to provide around $20 billion of cash that can be put toward debt reduction.
Without taking anything else into consideration, that move alone would trim long-term debt from $75 billion to $55 billion. That's an over 25% reduction after a single transaction. It is a pretty big deal and will go a long way toward getting GE back on a better financial path. It will still be more heavily leveraged than peers, but Wall Street's concerns about debt should ease greatly.
The only problem is that there are, of course, other moving parts on the balance sheet. That includes "non-current compensation and benefits" liabilities (pension obligations) of over $30 billion. And "insurance liabilities and annuity benefits" liabilities (largely leftover from GE's foray into financial services) of roughly $40 billion. In other words, the sale of assets to Danaher is important in that it helps alleviate the sense of urgency, but it doesn't completely solve the bigger-picture leverage problem.
Interestingly, General Electric actually reports its balance sheet in two different ways. It has a consolidated balance sheet and one that breaks apart its industrial business from its finance business. That's a sign of the complexity of the situation, but helps to clarify where the problems reside. For example, virtually all of the pension liability rests with the industrial business and all of the insurance liability and annuity liabilities are on the finance side.
When you look at debt, the company reports $15 billion in long-term debt on the industrial side and $33 billion on the finance side. Those two numbers don't add up to $75 billion. There's also a line item for "long-term borrowings assumed by GE." This item is empty on the consolidated balance sheet, but is $26 billion on the industrial side and $17 billion on the finance side of the separated balance sheet. Those two figures don't add up to $75 billion, either. Add all of them together and you end up with a number over $90 billion. So what is going on? That's not easy to answer because there are still a lot of unknowns at GE, particularly on the finance side of the equation. In fact, this math alone should be enough to quash any interest a conservative investor might have in GE.
In a year it will be better, but...
There's no question that General Electric is working hard to mend its debt-heavy balance sheet. It should look much better a year from now than it does today. However, "better" does not mean "healthy." In 12 months, GE will likely still be a heavily leveraged industrial company continuing to deal with the fallout from its ill-advised foray into finance. And none of this even takes into account the actual operations of the company. Although GE's stock remains around 65% below the highs it saw in 2017, suggesting there could be some turnaround potential here, conservative investors and those that prefer to keep things simple should probably continue to sit on the sidelines.