Forget Welch, GE Has Its Own Problems


By Gene Marcial How do investors regard General Electric (GE) these days -- after all the brouhaha over the retirement perks that former GE Chairman and CEO Jack Welch has received? The Securities & Exchange Commission started an "informal investigation" into Welch's lavish benefits, including luxury housing, private jet travel, and lots more that were revealed in a divorce proceeding filed by Welch's wife. The legendary CEO then acted quickly: He told GE he was giving up most if not all of the perks that were originally handed to him as incentives to remain at GE when he was up for retirement (see BW Online, 9/18/02, "Even in Retreat, Jack Welch Leads").

Analyst Scott R. Davis who follows GE at Morgan Stanley says the issue is having no material effect on his appraisal and recommendation on GE. A week before this controvery hit the headlines, Davis had made an analysis of GE and what investors -- mainly institutions, hedge-fund managers, and Street analysts -- were thinking about it.

Even then, Davis rated GE as an "equal-weight" holding -- meaning investors should hold shares in GE equal to the weighting of the stock in the S&P 500-stock index. For investors who already own GE, "they shouldn't sell," he advised. But for those who want to buy or add GE shares to their portfolio, "they should wait until the stock dips below 25 a share," he said.

NO BEARING NOW. When to sell GE stock? When it rallies to the mid-30s, specifically past 36, says Davis. It's now trading around 26.

Davis continues to hold his equal-weight rating on GE, the latest "scandal" notwithstanding. The issue of outsize benefits to Welch doesn't affect Davis' rating because it has no bearing on how GE's current management is performing, the analyst argues.

"It's difficult to judge a company based on an agreement it made [with Welch] at a different time -- when the economy and the stock market were doing much better," notes Davis. "Today, the situation is far different from when GE granted those perks and payments," he adds, with the economy now coming out of a recession and the stock market in a very bearish mode.

"TOO MUCH UNCERTAINTY." At the time GE instituted those incentives, they might have been justified based on the "premium value" of Welch, says Davis. In the current atmosphere, however, while they're suspect, they aren't relevant to GE's current operations, he adds.

Based on fundamentals, "too much uncertainty remains for me to get more construcive on GE stock at current levels," says Davis. Many other investors agree. In his talks and meetings with a variety of them, Davis found that the buy-side analysts -- those who work for institutional investors, such as banks and insurance companies -- remain "overwhelmingly negative" on GE. But what's interesting, he adds, is that fund managers are "generally positive" (over 80% of them).

As reasons to be bullish, they typically cited factors such as the stock being oversold, the extremely bearish sentiment toward it, GE's relatively good earnings growth and dividend yield, and the overly underweighted positions of fund managers. The bears, on the other hand, cited degrading fundamentals in some of GE's units, including power and aerospace, earnings numbers that are falling, unrealistic growth-rate expectations, declining return on invested capital, and large risks with some big loans at GE Capital.

HIGHTENED WORRIES. Hedge-fund managers, who are also generally bearish, believe that most investors don't yet understand the risks at GE Capital. They also worry that the stock is trading at a premium to its estimated sum-of-the-parts value. Davis conferred as well with European investors, many of whom have turned into "near-term bears" and have cut back their GE holdings. They had been die-hard fans, having made a lot of money in the stock over the past five years.

"We share many of the concerns of these investors," says Davis. More recently, he says, his worries heightened because of the weak summer orders and risks in GE's power and aerospace markets.

"At present, we have little confidence in our below-consensus 2003 earnings forecast" of $1.79 a share. For 2002, his estimate is $1.65, vs. 2001's $1.41.

His bearishness is tempered by the possibility, he says, that these concerns might already be reflected in the stock's current price. In addition, given GE's entrenched position as a market proxy, any rally in the S&P 500 would likely result in a "solid stock performance" by GE -- despite its weakining fundamentals.

All bets are off if earnings fall short of estimates, possibly because of a backsliding economy, according to Davis. So if a single stock could be the harbinger of bad or good news in the stock market, it's GE. Only trouble is, right now this stock-to-watch is emitting mixed signals. Marcial is BusinessWeek's Inside Wall Street columnist


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