For years, bears have criticized General Electric (GE 2.62%) for its heavy debt burden. Not too long ago, it was a reasonable concern: At the beginning of 2018, GE was drowning under a $134.6 billion debt load.
However, GE has worked hard to sell assets over the past three years, allowing it to pay down debt. And while the company's debt load may still seem high today, General Electric has a clear plan to significantly reduce its leverage and restore its balance sheet to health over the next couple of years.
Solid progress so far
Since recognizing the need to pay down debt a few years ago, GE has sold a slew of assets to raise cash. For example, it divested various pieces of its power business, a healthcare IT business, and its transportation segment, netting over $10 billion of cash proceeds.
Next, GE began selling off its stake in Baker Hughes in late 2018, raising billions of dollars. Most significantly, it offloaded its biopharma unit to Danaher in early 2020 for net cash proceeds of $20 billion. The GE Capital unit has steadily sold off assets, too.
Thanks to these moves, GE has already reduced its debt load dramatically. The company ended last quarter with just $71.4 billion of borrowings. (It also has a pension deficit of a little more than $20 billion.) GE will reduce its debt further next month, thanks to a recently launched tender offer that should enable it to retire several billion dollars of debt.
GE Financial Debt (Quarterly), data by YCharts.
One more big asset sale ahead
In March, General Electric announced its biggest asset sale yet. GE Capital will sell its GECAS aircraft leasing unit to top rival AerCap for total consideration of $31 billion, consisting of $24 billion of cash, $6 billion of stock, and $1 billion of either cash or notes.
GE will use the proceeds of this deal to help fund an estimated $30 billion of debt repayments this year. However, in the near term, the transaction won't actually reduce its reported leverage. After completing the GECAS sale, General Electric plans to fold its GE Capital unit -- and its debt -- into the core industrial business for financial reporting purposes.
As a result, the company estimates that it will end 2021 with gross debt of $70 billion (including its pension deficit). That could give it a leverage ratio -- net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA) -- of around 6: more than double its long-term leverage target of 2.5 times EBITDA.
It won't take long to reach the leverage target
At first glance, it might seem that GE still has a long way to go to get its debt under control. However, the company could reach its leverage target in as little as two years. First, GE expects to end 2021 with about $25 billion of cash on hand. That would leave it with at least $10 billion of excess cash that it can use to continue repaying debt.
Image source: General Electric.
Second, GE will finish selling its Baker Hughes stake by 2023. It recently unloaded nearly $1 billion of shares, but the company still holds approximately 268 million shares of its former subsidiary. Based on Baker Hughes' recent trading price of around $25, those shares are worth roughly $6.7 billion.
Third, GE will eventually sell the AerCap shares it receives in the GECAS deal. Those could be worth $6 billion -- or even more, if investors bid up the price of the aircraft leasing giant as the airline industry recovers from the COVID-19 pandemic.
Fourth -- and perhaps most importantly -- while the pandemic has temporarily reduced EBITDA for GE's aviation unit, that segment's profitability is already bouncing back. That recovery will likely accelerate next year as the global economy reopens and air travel volumes rebound.
This EBITDA recovery will boost GE's free cash flow, enabling some organic debt reduction. In addition, higher EBITDA will allow the company to support a greater debt load while meeting its long-term leverage target. By the end of 2023, General Electric should have a very healthy balance sheet. Combined with its expected post-pandemic earnings recovery, that could send GE stock flying higher.
