General Electric Downgraded as it Enters 'Transitional Period'

NEW YORK (TheStreet) -- General Electric's (GE) stock is fairly valued, considering the major transition the company is going through to hit CEO Jeff Immelt's goal of deriving 70% of operating earnings from industrial businesses, according to Oppenheimer analyst Christopher Glynn.

The analyst on Thursday downgraded GE to a "perform" rating from "outperform," because "2014-15 represents a transitional period" that projects a compound annual growth rate for earnings-per-share in the mid single digits over the next two years.  Glynn estimates GE's operating earnings will grow from $1.64 a share in 2013 to $1.70 in 2014 and $1.80 in 2015.

General Electric CEO Jeff Immelt's long-term goal for GE has been to transition the industrial giant from over-reliance on GE Capital, its financial service subsidiary.  GE Capital contributed 47% of GE's operating earnings during the third quarter.

GE in November announced it would spin off its North American consumer finance unit through a transaction that will be tax-free foo GE shareholders and include an initial public offering of up to 20% of the equity in the new company.  The IPO is expected to be completed "later in 2014," after which General Electric plans to make a complete exit from the consumer finance business by distributing its remaining 80% stake of shares in the new company on a tax-free basis during 2015. 

The company also said it might decide to complete the disposal of the consumer finance arm by "selling or otherwise distributing or disposing of all or a portion of its remaining interest in the Retail Finance shares."

So there's some dilution for investors to consider in advance of the completion of the spinoff, which will result in "estimated $0.20 of 2015 dilution from NA Retail Finance (NARF) exit that we expect is roughly half offset by reduced share count (split-off tender plus base buyback)," Glynn wrote in a note to clients.

GE had already made tremendous progress in shrinking GE Capital, with the unit's "ending net investment" (ENI), excluding non-interest bearing liabilities, cash and equivalents, declining to $385 billion as of Sept. 30, from $425 billion a year earlier.  GE Capital will shed another $50 billion or so through the spinoff of the consumer finance unit, bringing the unit within Immelt's long-term ENI target range of $300 billion to $350 billion.

There's an eventual silver lining for investors after the transition is completed, which is a greater ability for GE to deploy excess capital through higher dividends and share buybacks, which can significantly reduce the share count, thus pushing EPS higher.

The long-term initiative to trim GE Capital will improve GE's liquidity allowing the company to continue providing middle market commercial financing and continue to lend to its industrial customers, while avoiding the type of liquidity crisis it faced in 2008. At the height of the U.S. credit crisis, liquidity in the commercial paper market dried up, forcing GE to rely on the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program (TLGF) and the Federal Reserve Bank of New York's Term Asset Backed Securities Loan Facility (TALF).

Despite the neutral outlook for GE's stock over the next two years, Glynn wrote, "We continue to view shares as a solid store of value, with the 3.2% dividend yield, a case for solid industrial organic growth drivers, and understated 2014 earnings power given about $1B pretax net restructuring (~7c) included in our estimates."

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