GE: That Was More Than Just A 'Reset'
Summary
- The company held an Investor Update Meeting and it was not well received by the market.
- GE cut its dividend by 50% and guided for lower-than-expected 2018 adjusted EPS and Industrial FCF.
- It is hard to fight the tape, but I am staying long the stock.
If you have not heard yet, General Electric (NYSE:GE) held its Investor Update Meeting on Monday, November 13, 2017. During the meeting, Mr. Flannery, CEO laid out his vision for the company and talked through his plans to reposition this storied industrial conglomerate in the quarters/years ahead. In addition to providing the 2018 Operating Framework, Mr. Flannery also discussed in great detail the reason for the 50% haircut to the dividend (from a quarterly amount of $0.24 to $0.12).
So, as you could guess, GE shares have been under pressure since the dividend cut and disappointing 2018 guidance was announced.
(Source: Nasdaq)
Taking a step back, the underperformance of GE's stock over the last year shows that it is hard to fight the tape. I have an overweight GE position in the R.I.P. portfolio so I have felt the pain over the last few days - and honestly over the last few years - but I plan to stay long the stock, even after the disappointing investor meeting.
Simpler Is Better
Investors have raised concerns about GE's use of multiple earnings and operating metrics - e.g. Continuing operations EPS, Industrial operating + Verticals EPS, Industrial CFOA, etc. - so the company has decided to simplify things. Going forward, management plans to change their reporting language with a focus on only a select few metrics:
To highlight the two most important items, the company will be using adjusted EPS, instead of a long list of earnings metrics, and will switch from Industrial CFOA to Industrial FCF. This may not sound like much but I believe that these changes will greatly improve transparency and will help eliminate the ongoing gripes from analysts about not knowing what metrics to value.
I believe that this is management's attempt to keep the Street happy and to show that Mr. Flannery is really trying to distance himself from the Immelt era. Remember, you can only take one step at a time. I fully expect more market-friendly changes to occur with Mr. Flannery in charge.
Down Goes The Dividend. It Had To Be Done.
Most analysts predicted that GE would cut the dividend but the estimates for the reduction were all over the map. I previously called for the dividend to be reduced by 50% but, to be honest, I did not know how dire of a situation the company was actually in.
The company's $0.96 dividend adds up to over $8B on an annual basis, and GE is guiding for only $3B in Industrial FCF for 2017.
The funds are just not there. In a recent interview (this is a great interview, please watch), Jamie Miller, CFO, discussed the company's new dividend and stated that the $0.96 annual payment was simply not sustainable. I could not agree more.
Looking forward, GE is guiding for Industrial FCF to be in the range of $6B-$7B for 2018. This estimate leaves little wiggle room (60-70% payout) and it is exactly why some pundits are already calling into question the long-term sustainability of the new dividend amount. My thoughts: Mr. Flannery (and the board) fully understand the damage that another dividend cut would cause so I believe that they appropriately evaluated the situation and established the new dividend at a sustainable amount.
More Than Just A Reset
The company provided the following 2018 Operating Framework:
This is more than just a reset. Remember, this is the same company that was recently calling for $2 in adjusted earnings per share for 2018 (this happened only a few months ago). This lowering of the 2018 guidance is more than just ratcheting down expectations, I believe that this seriously calls into question the accountability of the previous management team, and more importantly, board oversight. I guess Mr. Flannery agrees, because it was announced that GE would be shaking up its board.
Moreover, Mr. Flannery highlighted the fact that 40% of the leadership team is new since June. The new blood should be welcome news to shareholders because it was obvious that Immelt was running wild and that no one held him accountable. Now, let's hope that the changes usher in a new approach to oversight.
I highly recommend that GE shareholders and prospective investors listen to/watch the Investor Update presentation because it provides great insight on the company's industrial businesses. However, I believe that management did not go far enough, especially when it comes to what assets will be disposed of. I was expecting for Mr. Flannery to lay out, in detail, what assets were going to be sold/spun off and I also expected for a final decision to be made on Baker Hughes, A GE Company (BHGE). I know that he would have shown his hand if he had given specifics but, in my opinion, the devil is the details and the lack of information allows for others to dictate the narrative. The uncertainty only added fuel to the selloff and I do not see shares stabilizing until the financial community better understands management's intentions. Therefore, it could turn out to be a very bumpy ride through the rest of this year.
The Right Guy?
I have been impressed with Mr. Flannery so far. He gets right to the point and seems to be laser focused on properly allocating funds and making the necessary changes at a company that appeared to have had little direction over the last few years. It is definitely too early to know if Mr. Flannery is the right guy to lead GE out of its current situation but I think that he has taken strides in the right direction.
To get somewhat high level, I recently read a brief that talked about what it takes to be an exceptional CEO and it made me think about GE and, more specifically, Mr. Flannery. According to a McKinsey research report, there are three common trends that researchers observed from a study of "exceptional CEOs" when they first took over the job.
1) Get strategic
Mr. Flannery's hand was pretty much played when he took over GE, but it is impressive that he hit the ground running and looked at every aspect of this company before making decisions. Could he have provided more detail during the Investor Update meeting? Yes, without a doubt, but at least he realized the predicament that he was in and communicated the fact that he does plan to make significant structural changes.
2) Think Like An Outsider
Strike one. Mr. Flannery is an insider through and through but the one thing that I am encouraged by so far is that it appears that he is really trying to change the company's culture. Getting rid of company cars, jets and unnecessary expenses is not an easy decision to make during your first 100 days on the job. It will be a hard task but I like what I have heard so far from this seasoned insider.
3) Get Moving
As I described above, 40% of the leadership team is new since June. The company already announced $20B in asset disposals/spins and Mr. Flannery let it be known that a wasteful spending culture was a thing of the past. He is indeed moving quickly.
This all sounds like fluff, and it is, but I believe that Mr. Flannery is showing signs that he has plans to really usher in a brand new era. No one knows if he will succeed as CEO of GE, but, as a long-term shareholder that does not plan to sell anytime soon, I am encouraged by the tone at the top over the last few months.
Reasons To Stay Long
(1) Great businesses - the Aviation and Healthcare segments are GE's saving grace. I thought that Mr. Flannery would spin off or sell the Healthcare segment in order to focus more attention on the industrial businesses (the goal was to get simpler, right?) but it turns out that this segment will stay under GE's umbrella for the time being. With that being said, these two operating segments have great long-term business prospects but this has been getting lost in all of the noise. If Mr. Flannery is able to properly position the company for the future (i.e. Aviation, Power, and Healthcare focus), GE shareholders will like the makeup of the company that they are part owner of in 2018 and beyond.
(2) Rightsizing expense base - management is projecting for $2B plus in structural cost reductions in 2018, with a focus on taking a disciplined approach to operating its business segments. At this point, it is hard to believe almost anything that management says but, in my opinion, GE obviously has a lot of fat that could be cut. It will all come down to execution, and I personally believe that the new bonus metrics, coupled with the fact that an activist investor is acting as a watchdog, will put Mr. Flannery and team in a position to succeed in cutting out unnecessary costs.
(3) Improving sentiment - the market sentiment could literally not get worse, as most analyst have already jumped ship. It will take a long time for GE to win over the market again, but I believe that even a slight improvement would go a long way. This will play out well into 2019 but it has the potential to be a significant long-term catalyst for the stock.
(4) Valuation & Dividend - After the recent pullback, GE shares are trading in line with its peer group and the company has an above-average dividend.
| Price | 2018E | P/E Ratio | Dividend | |
| GE | $17.90 | $1.00 | 17.90 | 2.68% |
| HON | $147.32 | $7.79 | 18.91 | 2.02% |
| UTX | $118.80 | $6.84 | 17.37 | 2.36% |
| MMM | $229.33 | $9.63 | 23.81 | 2.05% |
| Averages | 19.50 | 2.28% |
(Source: Data from Yahoo! Finance; table created by W.G. Investment Research)
GE shares should not be trading inline with the likes of Honeywell (HON) but I expect for shares to continue to decline over the next few months so valuation will soon be a reason to be interested in GE, of course, in my opinion.
Bottom Line
To start, it would be the understatement of the year to say that I have misread GE's woes (i.e. near term prospects) over the last few quarters. Do I plan to sell GE shares now that they are trading in the high teens? No, but there is no denying the fact that the Power business is in more than just a rut, and it is definitely going to take an extended period of time for Mr. Flannery and team to clean up the mess that previous management left them. This is going to cause a lot of downward pressure for the stock because GE heavily relied on this operating segment to grow earnings over the last decade.
However, not all is bad. The global economy is growing (for example, according to Factset, S&P 500 companies with more global exposure reported higher earnings growth in Q3 2017), the aviation and healthcare industries have promising prospects, and the oil & gas industries seem to be finding their footing. It is all of the 'other' stuff that is dragging down GE's results and muddying the water so until Mr. Flannery truly changes the narrative, this stock is likely to float around the mid-to-high teens.
I believe that Mr. Flannery and team underpromised with their 2018 guidance so I hope that they are also able to over deliver. There was a lot to like about what I heard from management at the investor meeting but, on the other hand, they failed to clearly articulate what the "new" GE will look like. In light of this, I would wait before putting new money to work in GE. But, I believe that long-term investors (at least three-to-five year time frame) should seriously consider staying long.
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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, BHGE. 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.