The Trouble with Money
General Electric Company (NYSE:GE) is a giant conglomerate that has refocused on its industrial businesses. The decision to get back to basics was pretty much forced on the company by the deep 2007-2009 recession. The company’s finance group had been growing steadily more important over the years, but nearly crumbled when the financial markets dried up. As a result GE was forced to take a government bailout and cut its dividend.
Getting Healthy
In 2009, the finance arm essentially stopped contributing to General Electric Company (NYSE:GE)’s bottom line as it worked to right itself. Payments resumed last year and are scheduled to be around $6.5 billion this year. Clearly, the finance arm has a lot to offer if it is managed properly.
In fact, GE needs to have a finance arm to help customers buy its large and expensive products. So, the division should never go away. That said, it operated, and still operates, in some areas that aren’t core to GE’s industrial focus.
Using the Cash
The money from GE’s finance division is likely to help fund its share buybacks and shareholder dividends. However, General Electric Company (NYSE:GE) is usually on the hunt for acquisitions, so these payments can also be used to bolster the industrial business’ growth. That will help to reduce the importance of the finance arm over time.
Lufkin Industries, Inc. (NASDAQ:LUFK) is the most recent “big” purchase. The bolt on acquisition will cost around $3 billion. Although the sale of NBC helped fund this deal, it is representative of the changes taking place at GE.
Lufkin Industries, Inc. (NASDAQ:LUFK) operates in the Oilfield and Power Transmission areas, both of which tie into GE’s Oil & Gas group. That GE unit grew earnings 16% in 2012, making it the top performer across the company’s industrial divisions last year. The Lufkin deal should help keep that growth going.
Lufkin Industries, Inc. (NASDAQ:LUFK) is an all-cash deal, so clearly the company is putting its cash to work. That said, Lufkin investors should lock in their gains—just in case the acquisition falls apart. Although Lufkin continues to perform well as a stand alone entity, it is highly unlikely that there will be much upside beyond the current price levels.
The Risk
General Electric Company (NYSE:GE)’s first quarter results, however, show a big risk to the company’s renewed industrial focus. Revenues and profits in the industrial business were down 6% and 11%, respectively. The finance arm saw revenues advance 2% and profits jump by 9%. That type of leverage is a hard drug off of which to wean oneself.
Investors have to keep a keen eye on the finance arm, lest management allows it to grow disproportionately large again. On that front, Bloomberg recently wrote about GE considering a spin off of parts of its finance arm. That would likely be a good move for shareholders, but at this point is little more than conjecture.
Less Baggage
Investors looking for an industrial giant without the same level of finance arm risk might want to look at Siemens AG (ADR) (NYSE:SI). The company is a bit smaller than GE, but is one of the industrial giant’s next largest competitors. More important, Siemens AG (ADR) (NYSE:SI)’ finance arm is more focused on supporting Siemens’ business than GE’s finance arm. If General Electric Company (NYSE:GE) does a partial spin off of its finance divisions, it would probably start to look more like Siemens AG (ADR) (NYSE:SI).
That said, Siemens’ profit margins have been around three percentage points lower than GE’s over the last couple of years. The company recently announced plans to cut thousands of jobs in an effort to increase efficiency. So, there is reason to believe that profit margins could improve over the next couple of years as cost saving work through to the bottom line.
Not an Either or
Both GE and Siemens shares are off of their highs. GE’s yield is a little over 3% and Siemens’ yield is a little under 3%. Moreover, GE has been focusing on returning value to shareholders via dividends. As such, income investors are probably better off with GE so long as keen attention is paid to the still large finance arm.
Investors who have been looking at General Electric Company (NYSE:GE) as a turnaround play, however, might want to take a quick review of Siemens. They are similar companies, but GE might be at a point where the good news is already out. Siemens, which is trading at a lower P/E multiple than GE (which itself is trading at a P/E below some of its peers), has the potential for margin improvement through cost savings. That could lead to stronger than expected bottom line performance at Siemens and potential upside for the stock.
The article A Slowly Shrinking Finance Arm originally appeared on Fool.com and is written by Reuben Brewer.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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