GE Manufactures a Higher Rating

A General Electric plant last year. The company’s third-quarter results on Friday will, aside from outlining sales and profit, be a progress report on the execution of its plan to exit from most financial businesses. ENLARGE
A General Electric plant last year. The company’s third-quarter results on Friday will, aside from outlining sales and profit, be a progress report on the execution of its plan to exit from most financial businesses. Photo: Thibault Camus/Associated Press

“Indugital” sounds about as clunky as “findustrial,” but it will be a lot less awkward for General Electric GE 3.39 % Co.

That first portmanteau is being used in advertisements for the company that, until recently, got the lion’s share of profit from shuffling around pieces of financial paper.

GE wants people, and especially investors, to know that there are really two radical transformations going on at the iconic company. The one that has investors most excited is the disposal of a huge finance business that made GE a “systemically important financial institution,” along with a return of much of the cash raised to shareholders. The other is the growing sophistication of the core industrial business as devices such as wind turbines and jet engines are tweaked remotely through the Internet.

Friday’s third-quarter results will, aside from outlining sales and profit, be a progress report on the swift execution of the plan to exit from most financial businesses in April. Nearly everything has or is being sold. The question investors now have to ask is where they stand compared with the day before the announcement.

On the one hand, transformations cost money and incur taxes, including cash repatriated from overseas. GE touts that it will return $ 90 billion of cash to shareholders over the 2015-2018 period. Analysts, though, have cut forecasts for earnings per share over that four-year period by a cumulative 71 cents, according to FactSet.

For perspective, analysts in March expected GE to earn $ 1.73 a share this year.

ENLARGE
Photo: The Wall Street Journal

On the other hand, disposals change perceptions of a company. Pure industrial businesses fetch a higher valuation than do pure financial ones. So it was natural that GE’s forward price/earnings multiple would climb as it changed its stripes.

The trouble is that the earnings that the more-focused company will generate going forward are skewed by one-time costs associated with discarding the finance unit. So investors shouldn’t simply extrapolate from average multiples of pure-play industrial peers.

Even assuming those costs vanish after 2018, GE’s rally since the announcement reflects about double the rating boost it actually deserved. It wasn’t magic, it was prestidigitifinancial engineering.

Write to Spencer Jakab at [email protected]


WSJ.com: Markets

About The Author