General Electric asked investors to do some difficult math last week about its balance sheet and accounting, and the investors balked. Shares fell as shareholders digested a lot of news related to complicated debt actions, asset sales, and accounting consolidations. In the end, the outcome—less debt is a good thing, but the one thing that investors hate is confusion.
But on Wednesday, General Electric (ticker: GE) CFO
Carolina Dybeck Happe
offered clarity on the company’s debt plans, telling investors exactly how the conglomerate will manage its debt between now and 2023. The good news: More debt reduction is on the way, and GE is taking a conservative and transparent approach toward its debt management. Investors are breathing a sigh of relief, and the stock is up.
At one point this past week, GE shares were down about 13%, falling to just above $12 from more than $14 a share. Shares have since bounced, and are up 2.6% to about $13.50 in Wednesday afternoon trading. The
was up 0.3%.
At the end of 2020, General Electric had $104 billion in total debt held at both its industrial business and GE Capital. After the sale of GE’s jet-leasing business, General Electric Capital Aviation Services—or GECAS—to AerCap (AER) closes toward the end of the year, GE expects to have about $70 billion in total debt. The company then plans to pay down an additional $25 billion in debt. By about 2023, total debt should fall to about $45 billion, the company said.
GE’s target for net debt to Ebitda (earnings before interest, taxes, depreciation, and amortization) remains at 2.5 times, but that number now includes all the legacy debt from GE Capital. Previously, GE had two debt goals: 2.5 times net debt to Ebitda for its industrial arm, and 4.5 times debt to capital for GE Capital. Now the only goal is 2.5 times net debt to Ebitda for the entire company, which GE says it can hit in 2023. That’s one reason the debt guidance is conservative: The company is adding extra debt from GE Capital, without moving the target.
Net debt to Ebitda is a common measure of financial leverage. The ratio for the S&P 500 is less than 2 times. And the GE Capital debt doesn’t come over to the industrial business by itself. GE Capital has assets, too, which bring in cash. One of the sources of the extra $25 billion in debt reduction will be the runoff of legacy GE Capital assets.
Investors should also note that GE chooses to include its underfunded pension liability in its debt calculations, a conservative step. A pension deficit is the difference between pension obligations owed to employees and the pension assets set aside to pay employees.
Pension deficits matter, but aren’t considered typical debt. The reason for that is interest rates. Pension obligations are a stream of cash flows paid far into the future. There is no maturity date, like with a bond, when the company owes a large fixed amount. In addition, regulators require companies to discount the pension obligations to be paid at very low rates of interest. Regulators’ thinking goes something like this: The cash should be discounted at a government bond yield because that rate will determine the size of the cash pile needed if all the pension assets were invested in those government bonds.
When interest rates are low, the cash pile needs to be huge. The 10-year treasury bond yield is about 1.6%. If GE needed to pay $1 billion a year to pensioners, and only bought 10-year bonds, it would need a $63 billion cash pile to pay obligations out of just the interest on the bonds. But if government bonds yielded 5%, the cash pile would only need to be $20 billion.
However, GE and other companies invest pension assets in stocks, corporate bonds, and other assets that earn much more than government bond yields over time. In that way, the pension deficit is always overstated. A good rule of thumb for investors is that if a pension plan is 85% or 90% funded, then extra cash won’t be needed to top up pension assets.
Happe, in fact, pointed out that with bond yields on the rise, the GE pension gap, currently at about $20 billion, could fall by $4 billion or $6 billion. That’s even more good news for GE: debt reduction without having to spend a dime.
After the AerCap deal’s expected close near the end of the 2021, GE’s net debt to Ebitda ratio will be about 6 times—too high compared with industrial peers and well above GE’s long-term goals. But that is based on 2020 Ebitda, which was dragged down by the Covid-19 pandemic. Going forward, GE will have a lot on its side to help it stay on track to meet its net-debt-to-Ebitda goal of 2.5 times—an economic recovery, the additional $25 billion in debt paydown, and about $15 billion in cash that it plans to keep on the balance sheet.
Other sources of debt reduction after the jet-leasing sale will be internally generated cash flow as well as the company’s equity stakes in
It’s still a lot to digest. But the added detail provided by the company should help out investors a lot.
Write to Al Root at [email protected]