- Issues that led to General Electric’s exit from the Dow
- Recent performance and future outlook
- Analysis of the share prices of the companies after exiting the Dow in recent history
General Electric (GE), which is one of the most prominent global conglomerates and was once considered the most valuable company in the world is facing troubles for the past few years. This has led many market analysts to speculate on its exit from the S&P Dow Jones Indices.
Finally, the iconic maker of light bulbs and jet engines and one of the original members of the S&P Dow Jones Indices was replaced in the 30-component index by the drugstore chain Walgreens Boots Alliance Inc. on the backdrop of its persistently low performing stock prices. GE’s stock prices have been facing hard times, it declined by 26% since January 2018 and is currently trading around 50% less than the same period in 2017.
Although, this is not the first instance, wherein the company was removed from the Dow Index. It also faced a removal in 1898 only to return 7 months later. It was removed again in 1901, but was reinstated in 1907 and continued to be part of the index up to June 2018. The recent exit is a sign of the company’s financial struggle and an ongoing shift in the type of companies that are considered key indicators for representing the US industry as a whole. Technically, the addition to a major equity market index signals a company’s arrival to an elite corporate club of the United States, while a removal is considered a red mark on its status.
However, the Dow is not the usual index as it is weighted by the stock prices of the components rather than their market value. It is for this reason that GE was removed as its share prices were going down with GE’s weight to the index being reduced to a mere 0.35% and made its influence in the price-weighted average negligible. Unlike GE, the pharmaceutical company; Walgreens stocks doubled in the last 10 years. The S&P Dow Jones Indices press release stated that amid growing prominence of healthcare companies in the US economy, this switch from GE to Walgreens will be a better measure and representation of the economy and the overall stock market.
On the face of it, GE still stand strong, it is 18th on the list of Fortune 500 (global) as of 2017, based on its revenue of $121 billion (2017) and currently, it has a market cap of approximately $113 billion. Looking at the internals though, it is currently in the midst of restructuring which has not been easy transition for the conglomerate. Moreover, after divesting much of its underperforming units like oil and gas business, the company is left with the high-margin aviation and healthcare segments. However, it still has a sizeable share coming from renewable energy unit, its struggling power units and GE Capital has not been of much help either. The market reports also state that the company has fewer assets that it was unable to sell, plus the liability from few troubled assets it unloaded post the financial crisis in 2008. The company is also under two ongoing federal investigations. One from the SEC for a $15 billion hit taken for covering miscalculations made in one of its insurance units and the other investigation from the US Justice Department in connection with the subprime mortgages. Furthermore, poor earnings have added to the challenges for the company, with the most recent report again falling short of expectations.
The profits for the conglomerate has been declining over the years amid multiple problems and woes. The company is dealing with a heap of issues including a huge debt load which has accumulated over the years, with its getting into bad deals (most notably the $9.5 billion acquisition of Alstom’s power business that manufactures coal-fuels turbines, which backfired as fossil fuels fell out of favour in important markets globally) and also overly aggressive rewards for its shareholders (spending almost $42 billion between 2010 and 2017 in buybacks and thereby, returning huge amounts of cash to shareholders and dividend rather than reducing its debt burdens), which has also added to cash problems for the company. GE’s (excluding GE Capital) borrowing as a percentage of total capital invested has increased from 9.2% (2013) to 48.9% (2017) making it highly reliant on the debt. Similarly, the alarming scenario for GE Capital’s debt to capital invested, which increased from ~77% (2013) to ~88% (2017) is another cause of concern. According to Moody’s, GE’s total debt to earnings ratio since 2013 has jumped from 1.5 to 3.7 in 2017. Additionally, a weak demand for industrial products from gas turbines to locomotives to oil industry equipment has escalated the problems for the conglomerate.
On a positive note, GE seems to be strategically working to tackle the aforementioned aspects and its exit from the Dow might not lead to a significant downgrading of its stocks and company as a whole. GE continues to be part of other major indices in the US, wherein the investment from fund managers, investment banks as well as other major financial institutions and the general public is higher. The primary reasons being, the small number of holdings (30 stock prices in the Dow) and the price weightage scheme (and not on the market cap scheme as seen in the S&P 500). Moreover, though not directly correlated, the data suggests that moving out of the Dow is not an end of the road for stocks. A look at the past data of companies that delisted from the Dow shows that not all have gone to the grave, in fact, most of them have fared better after the exit.
On the 26th of June 2018 (just days after its exit from the Dow Jones Industrial Average Index), GE released its plans for a corporate restructuring in terms of its business portfolio. The company will separate its healthcare division into a stand-alone company. In addition, the company also shared its intention to dispose of its interest in Baker Hughes and reiterated its intention to shrink GE Capital’s business. The company is in a bid to transform itself into a high-tech industrial firm focusing on aviation, power and renewable energy. Hence, with all the restructuring news, the market sentiments towards its stocks were lifted and it rallied to gain ~8%. This was the company’s best two-day gain in over three years and came just days after GE was dropped from the Dow Index.
GE’s structural change announcement on the 26th of June 2018, highlights its commitment to optimise its operations and divest its non-performing operations. This is a major shift for the company and is a move to remodel itself to be more successful from an old conglomerate tag with a broad collection of disparate businesses. GE is hoping that these structural changes will help to strengthen its balance sheet going forward by reducing its debt, building-up cash and further shrinking its non-performing businesses. Therefore, as a whole, the prospects look better for the company in the medium to long-term period.