General Electric: And The Beat Goes On, Or Does It?
Summary
- GE has beat the consensus EPS estimates in 7 of the last 8 quarters; however, Q3 2017 will likely be the first earnings miss in the last 2 years.
- There are rumors that a dividend cut is coming for GE in the near future.
- GE is a long-term buy at today's price.
To say that General Electric (NYSE:GE) has been a battleground stock would be the understatement of the year. Shareholders of this industrial conglomerate have been taken on a roller coaster ride over the last two years, and the recent trend has not been favorable for the loyal long-term holders of GE shares.
(Source: Nasdaq)
GE is set to release its Q3 2017 operating results later in the week and many pundits are already calling for the company to report a kitchen-sink type of quarter. While there are definitely significant risks that need to be considered (covered later in this article), I believe that GE's portfolio of businesses makes the company a great long-term investment at today's price.
And The Beat Goes On, Or Does It?
Per Yahoo! Finance, GE is expected to report EPS of $0.49 for Q3 2017. For comparison purposes, the company reported EPS of $0.32 for the same period in the prior year. Most people do not believe me when I tell them that this company has reported better-than-expected earnings in seven of the last eight quarters (and met the estimate in the other quarter).
(Source: Fidelity)
As shown, the company's EPS has been drifting lower over the last two years, but let's not forget that this company is in the midst of a major restructuring effort. Restructuring is not an excuse for GE and its management team but, instead, GE's earnings coming in at lower amounts now when compared to prior years is a direct result of the restructuring efforts. It is important to remember that this company has been selling its financing assets (over $200B over the last two years), replacing [some] of its financing earnings with earnings from industrial businesses (i.e., less risky, and more valuable earnings), and buying back shares hand over fist.
GE has reported industrial operating earnings growth over the last two years, but this fact is getting lost in the noise. For example, GE reported double-digit industrial operating EPS growth for full-year 2016.
(Source: Q4'16 Earnings Presentation)
More importantly, the company also reported growth in the first half of 2017.
(Source: Q2'17 Earnings Presentation)
Therefore, the earnings that matter (i.e., earnings from the industrials businesses that will be remain with the company after the restructuring is complete) have been trending in the right direction. It obviously helps that GE's management team has been able to expand its industrial margins so far in 2017.
(Source: Data from Q2 2017 10-Q; table created by W.G. Investment Research)
GE's industrial operating margins have increased by 3% YoY, which is encouraging based on the fact that the company's margin profile usually improves over the last six months of each year. Plus, as shown, the O&G segment was again a major drag, but this could soon change. Management still has a lot of work to do if the company is going to meet the industrial profit target set by the Trian Fund ($17.2B for full-year 2017), but at least the numbers are heading in the right direction.
Getting back to the company's Q3 2017 financial results, I am on the same page as many other analysts - GE's upcoming earnings release will likely not be anything to write home about (i.e., a kitchen-sink quarter). As such, GE will likely not beat (or even meet) the consensus EPS estimate for Q3 2017. I, however, do not believe that this means investors should jump ship and look elsewhere. As I recently described in this article, there are legitimate reasons to be bullish about GE's long-term business prospects.
Moreover, I am on record for stating that one or more of GE's major business units will likely get spun off or sold in the near future. So, the Honeywell (HON) news - Honeywell's management team recently announced that two operating units (Transportation Systems and Homes And Global Distribution) would be spun off by the end of 2018 - should be considered a positive development for GE shareholders. Let's take a moment to think about one scenario that may very well play out in the weeks ahead. Let's say that GE reports "disappointing" Q3 2017 operating results but there are improvements in the company's underlying metrics (cash flow, margins, organic order numbers) and then Mr. Flannery announces a "break-up" (one or more of its major operating units) of this storied company during the Investors Meeting in November 2017. In my mind, investors that sell their GE shares at $23 will regret it if this type of scenario plays out.
At the end of the day, I believe that the risk is to the upside when thinking about GE over the next five-to-ten years, even if the company reports disappointing quarterly results later this week. That, however, does not mean that an investment in GE comes without risks.
The Risk
The risk of a dividend cut is the number one topic that the bears have been running with over the last year. The latest rumor from Bloomberg is that Mr. Flannery will be reducing GE's quarterly dividend from $0.24 to $0.18 (full disclosure: this is only speculation and not has been confirmed by the company). There is no denying the fact that GE has had to borrow to service its dividend.
(Source: Q2 2017 10-Q)
The operating cash flows currently do not support the rich dividend, but it is important to note that management has already projected for the company's cash conversion to improve over the second half of 2017. While I believe that GE has the capacity to maintain its dividend payments (enough cash on hand and a debt rating that would allow for the company to add leverage), I now think that it may be wise to at least consider the fact that this company could be paying a lower dividend at some point in the near future. Mr. Flannery may truly want a total re-set, even if I think that it would not be wise decision on his part.
Bottom Line
GE is an attractive long-term investment at today's price, even if Mr. Flannery reduces the company's dividend. This company and its shareholders have taken a beating over the last ten plus months, but that does not mean that GE is unworthy of your investment dollars. To this point, consider that the company has: [1] de-risked its business profile (i.e., selling income producing financial assets and replacing them with industrial assets), [2] merged its oil & gas assets, [3] cut out unnecessary costs (e.g., delayed its headquarters buildout, cut corporate cars & jets), [4] bought small tuck-in acquisitions, and [5] several operating units under its umbrella that have promising long-term economics (Aviation, Power, Renewable Energy and Healthcare).
The company's operating results over the first half of 2017 has indeed left investors wanting more, but management has been able to meet (or beat) the guidance that has been provided to the Street over this same period of time. I expect for GE shares to drift lower over the next week or so, but, in my opinion, investors that have a long-term perspective of at least three-to-five years should seriously consider adding a position while shares are below $23. There is a lot to like about General Electric's business prospects, of course, if you are willing (and able) to stay invested for the long haul.
Author's Note: GE is a core holding in my R.I.P. portfolio and I have no plans to reduce my position in the near future.
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Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
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Disclosure: I am/we are long GE, HON. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.