Should GE Maintain Its Dividend?

Generally, when a company finds it necessary to slash its dividend it is a sign of significant trouble in the underlying business and most often the company’s stock drops in reaction to the cut. However, General Electric (GE) turned conventional wisdom on its ear Monday as the stock is up more than 15% because it appears increasingly likely that the company will need to slash its dividend sometime in 2009. It goes without saying that GE got into big trouble, especially in its finance division, GE Capital. As a result, the blue-chip company’s stock has steadily declined more than 60% over the past year. The company had boosted its dividend each year for the last 32, but broke that streak by holding quarterly dividends steady at 31 cents per share last year . This impressive track-record had to be broken because of the extremely difficult economy and now it looks as if CEO Jeffrey Immelt will at least consider the possibility of slashing the dividend later this year in order to reduce the company’s negative cash flow. (GE paid out $11.5 billion in dividends last year.)

There has been growing speculation among analysts that GE will need to cut its dividend in order to preserve its AAA credit rating. The credit rating is a reflection of the health of a company and, were GE to lose this top-tier rating, financing its already massive debt burden would be much more costly. With more than $693 billion in liabilities on its balance sheet at the close of 2008, the company can ill afford any development which raises its cost of capital. So, although no CEO likes to cut dividends paid to shareholders, especially for a company with such a strong history of increasing those payments, Immelt may have to do just that. It seems that unless there is a tremendous improvement in operating conditions before the second half of 2009, by cutting the dividend, Immelt would be doing what is in the best interest of shareholders by preserving his cash. A dividend cut will not guarantee GE’s AAA rating, but it would be a step in the right direction.

Now, GE clearly has enough cash on hand to continue paying its hefty yield of nearly 10%; however, is it wise in this environment? The company earned $1.78 and paid out $1.24 per share in dividends last year. So, for last year the dividend payout ratio for GE was nearly 70%, which is certainly more than we normally like to see. Looking ahead, that payout ratio could continue to worsen as consensus estimates have the company earning $1.27 in 2009 and $1.34 in 2010. It is clear that if GE’s actual results come in anywhere near estimates that the current dividend cannot remain intact.

We currently see GE as Greatly Undervalued because, compared to previous years, the stock looks extremely cheap using price-to-sales, price-to-cash flow and of course dividends. However, we anticipate 2009 could be another very tough year for GE and, as discussed above, its is saddled with a ton of debt. While GE may be one of the most diversified companies in the world, in this case we would hold off investing in GE shares, especially after the 15% run-up Monday. If you own GE, it probably does not hurt to hold the shares for the long-term because the odds are that the stock will return to more normal valuations as the economy rebounds in the next year or two. However, do not be surprised if the dividend yield going forward is lower, as a cut will probably be necessary in the quarters ahead.

Comments

[ex GE'er:]

As shareholders, we obviously want to keep the dividend. But the bigger question is "Can we trust Immelt?" The guy is either a pathological liar or a complete moron. How many times has he changed his guidance over the past year, even after Jack Welch openly stated Immelt has a credibility problem. For the first time in the history of this great company, market analysts are questioning its leadership. And so am I.

Feb 09 04:29 PM

[longandshort:]

I am so glad this article was publised, not because of its positive outlook on GE, but rather because it proves that market analysts are as fickle as the market itself. Till, last week GE was in the doomsday category, now everyone's happy with a dividend cut and that it is GREATLY undervalued. But a JPM analyst rated GE's stock at $9.00 just last week:blogs.barrons.com/stoc.... Whom do I believe??

Should GE be like Cisco or Google and not offer dividends, and yet maybe the stock price will skyrocket. How about analyzing companies with negative EPS, no dividend but share prices in the double digits.

Lets face it, share prices are a matter of supply and demand and investor emotion. Market analysts are bandwith hogs...

Feb 09 04:53 PM

[User 353976:]

While I do agree, GE will cut their dividend some time in second half of year/ 2010, what this blogger writes and what so many investors/ researchers do wrong is that they base the dividend payout ratio on net income. GE has an enormous of non-cash (read: depreciation, mainly) on their P/L that a prudent analyst would base the payout off of the cash flow. I actually think GE can maintain their dividend through 2009 but uncertainty in this environment and the ridiculous credit agencies may necessitate a cut. But base don cash flow I think even with a dive in cash flow(almost foregone at this point) they actually could maintain the dividend. The ratings agencies though I think do more bad than good especiually when they rated certain sub-prime securities investment grade when they were crap.

Feb 09 05:12 PM

[User 353103:]

Are all of you nuts? If GE loses it's AAA rating, it will have to pay much more for money for all it's businesses.It's huge credit business has flourished because it can borrow (issue bonds, long- and short-term loans, etc) at the best possible rate and loan it out with a high interest rate spread. Cut the AAA, you cut the spread, and it's credit business is doomed. The cost to GE in increased debt payments will be enormous. Obviously, no intelligent shareholder wants the dividend preserved.

Feb 09 08:09 PM

[U338129:]

Very good point on what the loss of the AAA rating means to GE. However, one has to ask, has it already been lost?

More importantly, should the AAA acronym mean that much anymore given how poorly the likes of Moody's and the S&P have performed in their own right in their analysis of all financial firms. In all honesty, a rating system like that should now be governed solely by the government (althought the SEC is too inept to do it obviously) because the private side has failed to regulate itself properly in that regard.

I will also say this. No loan entity in their right mind would deny GE credit versus smaller start-ups that, quite frankly, do not have the wide-scale expertise and "reach" to ensure a return on capital. You give money to GE and more than likely you're getting it back with interest. You give it to a smaller competitor that is just dependent on credit and you're running at a huge risk. Is that not the real essence of the mystical "AAA" anyway?

Feb 09 08:54 PM

[U338129:]

So, for the record, I think GE can indeed keep the dividend and still make it through this period just fine. Guess what would happen to those that try to play games with GE in terms of credit (especially given what GE has coming to it in terms of business around the world). Those lenders will be left to the wayside and they know it.

I say GE should play bully at this time to the likes of Moody's and the S&P and see just how far they are actually willing to go. I think that if GE stood its ground, analysts from the likes of Moody's and the S&P would piss their pants because they will, at that point in time, become completely irrelevant.

Feb 09 08:58 PM

[Fliujniligui:]

I am used to companies stopping dividends and this no longer disturbs me.

Feb 09 10:08 PM

[epeon:]

The problem with the comparison with Cisco is that Cisco has been pretty much a dog for ten years. Cisco hit $20 about a decade ago. Since then it has done nothing. And the stockholder, for displaying such patience, received nothing.

If GE slashes its dividend, it slashes its stock price. I would look at GE as just another bank as would most investors. I think if the dividend were slashed in half, GE goes to 6.


On Feb 09 04:53 PM longandshort wrote:

> I am so glad this article was publised, not because of its positive
> outlook on GE, but rather because it proves that market analysts
> are as fickle as the market itself. Till, last week GE was in the
> doomsday category, now everyone's happy with a dividend cut and that
> it is GREATLY undervalued. But a JPM analyst rated GE's stock at
> $9.00 just last week:blogs.barrons.com/stoc....
> Whom do I believe??
>
> Should GE be like Cisco or Google and not offer dividends, and yet
> maybe the stock price will skyrocket. How about analyzing companies
> with negative EPS, no dividend but share prices in the double digits.
>
>
> Lets face it, share prices are a matter of supply and demand and
> investor emotion. Market analysts are bandwith hogs...

Feb 10 04:06 PM

[Chancer:]

With many predicting major changes in future ling term stock market performance, I believe the real future of equity invesments will be with companies who pay dividends, as growth will be much slower going forward.

Although the trend with the recession favors dividend cuts, the future belongs to those who pay good dividends.

I suggest that maintaining a dividend now (if a company can afford to) will preserve shareholder loyalty and interest going forward.

Full disclosure: I do not own GE yet, because of all the speculation for a dividend cut, which may drive GE's price lower.

Feb 10 04:23 PM