How The Recession May Fix GE (GE)

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The financial year of 2008 is over for GE (GE) and investors are still debating whether the company will be able to both pay its dividend and keep its "Aaa" credit rating. Most of the concerns about the conglomerate focus on its financial unit.

GE was a $38 stock a year ago, and it now trades at $12. The fact that the firm is going through a recession should force GE to reconsider most of its cost structures.

Ratings agencies and investors believe that the the delinquency problems in the consumer and commercial credit parts of GE’s businesses will get worse. They are almost certainly right. That leaves open the question of how efficiently GE is willing to run its other businesses.

Wall St. has been begging GE to dump some of its operations because it cannot understand why a company would want to have a TV network and energy infrastructure operation under a common roof. That is academic. GE’s board has already decided to stick to the conglomerate structure.

The real question is how GE will run its divisions beyond finance to get as much operating income out of them as it can.

In the fourth quarter, GE made $3.9 billion on $42 billion in revenue. Revenue was down 5% from the same period a  year earlier.

GE’s growth engine is its energy infrastructure operation. There are a number of reasons to think that a large economic stimulus package in the US will increase the revenue from that unit. Its growth rate and margins are not safe, but they are supportable, so GE is unlikely to be lose the strength of its most important business.

The most important question about GE earnings for the next several years is whether management will be willing to sharply cut costs in operations like its medical device division and entertainment businesses. These were relatively strong performers not terribly long ago, but investment in health care and corporate spending on advertising are likely to be badly damaged in the downturn. If the economy pressures GE to push down costs in struggling businesses which should recover nicely with improved financial conditions, it will be better off in the next quarter and much better off a year or two out.

The criticism of GE has been that it set costs for success and not failure. That would be natural for any business. Optimism goes hand in hand with doing well as long as the process is not taken too far and as long as when it is time to cut, an enterprise cuts as deeply as possible.

GE is still too expensive to run. The recession may exorcise that out of the company. In the process GE may permanently improve profitability. At least as permanent as permanent can be.

Douglas A. McIntyre

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