General Electric (GE) has been making impressive progress over the past three months, and the stock has gained about 10% in that period. A change in strategy and investment in new growth areas have resulted in increased investor confidence. However, some investors still have doubts about the share repurchase program of the company, and believe the company could have done more.
Personally, I am not a big fan of share repurchase plans, and believe a consistent growth rate in dividends results in higher total return for investors. However, in order to clear the situation regarding the share repurchase plan, I have decided to conduct a thorough analysis of the share issues and repurchases done over the past five years. In addition, I will also go deeper in the dividend growth and free cash flows of the company along with the future growth prospects. First of all let's look at the trend in share repurchase and new issues.
Share Repurchases: Could GE have Done More?
As I mentioned in my previous article, GE was one of the most severely hit companies during 2008 due to its increased exposure to GE Capital. Banks were not willing to lend to other financial institutions and the Federal Reserve was fulfilling the duty of the lender of the last resort - money was tight and all the options were being considered to raise money. During 2008, GE issued shares worth $14.26 billion - the biggest share issue for the company over the past five years. At the same time, the company bought back shares worth $3.5 billion, bringing the net amount of new issue to $10.76 billion. In the subsequent years, the conglomerate issued new shares and bough back some amount of outstanding shares.
During 2009, share issue again exceeded the share buyback amount -- $837 million worth of new shares were issued and $214 million worth of shares were repurchased. However, in the following two years, share repurchases were higher than the new stock issues. GE issued $529 million and $709 million worth of shares in 2010 and 2011, respectively. Meanwhile, the company repurchased shares worth $1.79 billion and $2.165 billion during the same time period. So, it is clear that the trend is getting better in favor of investors as some investors would favor higher amount spent in share repurchases; however, total number of shares still remains substantially higher than pre-recession levels.
At the same time, the company has made considerable investment in new acquisitions, which have received mixed response from investors. A large number of investors seem happy with the strategy followed by the company to diversify itself towards new high-growth areas. However, a small section of investors believes that the money should have been spent on buying back shares. Personally, I believe GE made the right decision, and took into account the long-term health of the company. As I have mentioned before, a change in focus towards the core expertise of the company will bring handsome rewards in the long-term. The company is decreasing its exposure to GE capital and bringing focus back to its industrial arm, along with expanding into high-growth sectors such as oil & Gas, cloud computing and medical equipment.
How Has the Dividends and Cash Flows Progressed?
A decrease in cash dividends after the recession was a painful but extremely important decision for the company. In the second quarter of 2009, GE cut its quarterly dividend from $0.31 per share to $0.10 per share. The dividend remained at $0.10 per share for the next five quarters and the first post-recession hike came in the third quarter of 2010, when the company increased quarterly dividend to $0.12 per share. However, investors did not have to wait long for the next dividend hike as the company increased dividend by $0.02 per share in the next quarter. Since then, GE has been increasing cash dividend on consistent basis and current quarterly dividend stands at $0.19 per share.
Although the dividend still remains substantially below pre-recession levels, it has shown phenomenal growth over the past three years. Let's now move on to the cash flows and payout ratio. While evaluating cash flows for the purpose of dividends, my focus will be on free cash flows (Cash flows from operations minus Capital Expenditures). Free cash flows for GE took a nose dive in 2009 for obvious reasons and came down to $15.9 billion from $32.59 billion. Despite cutting its capital expenditures in half for 2009, the company was not able to match the previous year's free cash flows numbers. However, in the following year, free cash flows and capital expenditures want up. Capital expenditures for the company have been increasing at a higher rate than the operating cash flows. As a result, free cash flows have shown a downward trend over the last two years. GE increased its capital expenditures by more than 25% for each of the last two years, which resulted in declining free cash flows. At the end of 2012, free cash flows for the company stood at $16.2 billion.
Finally, let's talk about the payout ratio based on free cash flows. The payout ratio for the company was at 38% at the end of 2008, which came down to just 18% by the end of 2010. However, in the following two years, the payout ratio again made a big jump and currently it stands at 44% of free cash flows. GE paid cash dividends of $7.189 billion over the past twelve months and generated free cash flows of $16.2 billion, which puts its payout ratio at just above 44%. Overall, I believe the company has shown good commitment to shareholders and paid substantial amount of cash flows to investors. In the meantime, GE has also made some prudent moves by acquiring companies in growth areas, which will provide its business a substantial degree of diversification.
GE is the largest conglomerate in the world, and the company has a wide range of products. Recent acquisitions have given the company a platform to achieve substantial growth over the next five years. At the same time, GE is also one of the best dividend payers in the market, and the trend in dividends and cash flows indicates that further growth in dividends will come. Sometimes companies have to make decisions, which can be less attractive in the short-term; however, in the long-term, benefits of these decisions can be massive.
In my opinion, GE investors should be patient as the company is making all the right moves. Furthermore, I believe the decision was right to spend money on acquisitions instead of paying it back to shareholders. Ultimately, the benefit of these acquisitions will be going to the shareholders in the form of price appreciation.