GE GE Aerospace

By Matt Wirz 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 10, 2019).

General Electric Co. is battling to improve its credit rating, bucking investor expectations that the company is headed for junk-debt territory.

The Boston company has an investment-grade credit rating despite a 54% decline in its share price over the past year and a 9% drop in the price of its bonds.

If GE loses its investment-grade credit rating, its borrowing costs will rise, increasing pressure on its ailing industrial and lending businesses and threatening thousands of investors in its stocks and bonds.

Management has said it plans to improve the company's finances to reverse the rating downgrade in October to BBB-plus, three notches above junk-debt territory.

Credit-ratings firms say planned restructuring and divestitures should help GE avoid further downgrades, but investors are less sanguine. Here are some factors that will determine whether GE can avoid another ratings cut.

Losing Leverage

A key variable in GE's rating is its leverage ratio. In GE's case, that is a measure of its liabilities, around $115 billion, relative to the cash the company generates from its continuing operations.

The ratio compares debt to earnings before interest, taxes, depreciation and amortization, or Ebitda. The higher the ratio, the greater the risk that GE may have trouble servicing its debt, rolling it over when it comes due or repaying it.

Analysts estimated leverage for GE's core industrial business at 4 to 4.5 times in September, which already exceeds the norm for investment-grade bond issuers. Average leverage for companies rated BBB was 2.9 times in 2017, according to research by Pacific Investment Management Co.

Moody's Investors Service has said it could downgrade GE if leverage doesn't steadily drop toward less than three times; S&P Global Ratings said it could downgrade if the ratio stays above four times for two years.

Management's messaging on the issue has been mixed. GE Chief Financial Officer Jamie Miller said in June that the company would cut leverage to 2.5 times by 2020, mostly by divesting itself of assets to reduce its liabilities. But she rattled investors on an October conference call by apparently retreating from that target, saying, "We expect to make substantial progress toward this goal in the next few years."

"GE remains committed to strengthening the balance sheet including deleveraging," a company spokeswoman said this week. "Long term, we continue to target a credit rating in the single-A range."

Equity Sale

JPMorgan Chase & Co. stock analyst Stephen Tusa, who recommended selling GE stock in 2016 before it began the steepest part of its descent, said asset sales and spinoffs won't be enough for GE to hit its leverage target. The company will also likely need to issue $25 billion of new stock to pay off liabilities, he said in a December research report.

Mr. Tusa has set a $6 price target for the stock -- about 29% below the current price of $8.50 -- but raised his recommendation on GE to "neutral."

But a deal that size would be hard at the best of times and is probably out of reach, given GE's depressed stock price and investors' fear about a slowdown in the U.S. economy, analysts and bankers said. The largest equity sale ever of a stock under $10 was Citigroup's $17.6 billion deal in 2009, following the bank's bailout during the financial crisis, according to data from Dealogic.

GE CEO Larry Culp has said he has no plans to raise equity and that divestitures will be sufficient to pare debt.

Deal Risk

GE spent much of 2018 shedding assets worth at least $18 billion, according to company statements. The largest deals are yet to come: the expected sale of a 50.5% stake in Baker Hughes worth about $12 billion and the planned spinoff of GE's health-care unit into a new company, to which GE would transfer about $18 billion of debt and pension liabilities.

But the stock-market havoc of recent months has chilled mergers-and-acquisitions activity, and a selloff in oil has dragged Baker Hughes shares down about 32% since September. If the U.S. economy slows down, it will be even harder to close the large deals as planned.

"I'd like to see a little bit of progress in getting those asset sales done," said Lon Erickson, a portfolio manager at Thornburg Investment Management, who is holding off on buying GE bonds in his firm's $5 billion investment-grade bond fund. "Are they going to get the valuations they think?"

GE could also auction off GE Capital's lucrative aircraft-leasing business, an investment banker said. But that would gut GE Capital's revenues, a major risk if the lending division discloses more losses from its long-term insurance portfolio.

The Other Shoe

Investors were shocked by GE's revelations last year of a $6.2 billion long-term care insurance charge and a $22 billion charge from the power business. Now their biggest worry is that more negative surprises are waiting in the wings.

Where could the bad news could come from? One area is more insurance and power-related losses. Another is larger-than-expected settlements and fines from lawsuits and federal investigations involving GE's subprime-mortgage lending and accounting policies, CreditSights analysts Kristina Regan and Jesse Rosenthal wrote in a report.

While credit-rating firms are being patient with GE for now, "More shoes dropping could cause the agencies to shorten up on that leash," they said.

The deleveraging plan is susceptible to another hard-to-predict variable: the movement of U.S. interest rates. When rates rise, the company's pension fund makes more money on bond investments, shrinking its deficit, and analysts predicted that climbing U.S. Treasury yields would reduce the shortfall by about $9 billion in 2018. But rates have been falling in recent weeks amid concerns about slowing economic growth, a swing that could inflate GE's pension gap by billions of dollars.

Write to Matt Wirz at matthieu.wirz@wsj.com

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January 10, 2019 02:47 ET (07:47 GMT)

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