An Assessment Of General Electric's Dividend After The Cut

| About: General Electric (GE)

Summary

Following General Electric’s dividend cut, the company made two comments about how it would orient the dividend in the future.

Comparing General Electric’s dividend to that of its peers raises concerns about the company’s ability to match the dividend growth or payout of its peers.

General Electric has many headwinds and issues that will have an impact on the dividend’s future growth. Management may also be keeping the dividend on the table for future cuts.

General Electric is not a sleep-well-at-night dividend stock and its future dividend growth is in question in the near to mid-term.

General Electric (NYSE:<a href='https://seekingalpha.com/symbol/GE' title='General Electric Company'>GE</a>) dividend cut, dividend future, dividend growth, dividend analysis

Another disappointment has been served to General Electric (GE) investors as the company cut its dividend by 50% on November 13 in order to help the company save money since the dividend payout was greater than cash flow generation. Many investors were agitated at the thought of another dividend cut when JPMorgan (NYSE:JPM) presented its case on March 28, 2017. Deutsche Bank (NYSE:DB) followed suit a couple of months later. Many articles on SA began to appear also regarding the topic, some suggesting no dividend cut while others suggesting a dividend cut was likely. This was one of the signs I put forward in my article that analyzed a brief history of dividend cuts.

Now that the cut has happened, is there a possibility that the dividend will be cut again? Will the dividend grow again, and if so, by how much can investors expect or estimate? These are some questions that I will be looking to answer in this article.

The Dividend Trend

GE has paid a dividend for over 100 years. The dividend has been frozen on a number of occasions over that time. The company has only ever cut the dividend one other time, and that was during the financial crisis of 2008-2009. This recent cut nearly wipes out the entire dividend's recovery since that time, but the dividend did not fully recover to its pre-financial crisis payout either.

Source: Old School Value, chart created by the author

Under normal circumstances, I would project where I estimate the dividend's potential in the coming years, but this is not a normal event. From the following chart we see that GE has typically raised its dividend by two cents annually. The company also appeared eager to resume its dividend growth at a similar pace before the dividend was cut in 2009. This pace appears to have been too hasty or overly optimistic of future cash flow generation resulting from its mergers and acquisitions, which eventually did not materialize as well as the collapse of oil prices, which impacted several business segments.

Source: Dividendchannel.com, chart created and calculations completed by the author

Management provided some information regarding the dividend during its presentation on November 13. In it, the company indicated that going forward it would have a balanced capital allocation including R&D, CAPEX, the dividend, and the company's underfunded pension plan. More specifically, management made two statements regarding the dividend's future. The first was the company plans to align the dividend payment with cash flow generation. The second comes from the Q&A section regarding the payout ratio:

Martin A. Sankey (Analyst):

One is, first, in thinking about the dividend, historically, GE's policy is to pay out 45% of earning, of EPS as dividend. And coincidently, $0.48 a share on dividend divided by the midpoint of your guidance for next year is 45%. Is that how we should think about the dividend going forward?

John L. Flannery (CEO):

We're not giving a specific payout ratio. But I would say, you would look at our free cash flow numbers and look -- I'd look to our peer group around payout ratios and dividend yields, and you should expect us to be in that general vicinity.

First of all, let's take a look at cash flow generation. The company's cash flows have suffered particularly since 2014 when cash flows plummeted however, the trend has not been positive since 2010. GE estimates that it will generate between around $3B in free cash flow (FCF) in 2017 and between $6-7B in FY2018. With dividends now cut to $0.48 annually and with $8.672B shares outstanding, I estimate that GE will spend $4.162B in dividends next year assuming no additional cuts or buybacks. This means that GE may have sufficient FCF to cover its dividend for the first time in two years. The FCF payout ratio would equate to between 59% and 69% assuming GE earns its estimated $6-7B in FCF.

Source: Old School Value, chart created by the author

Analysts are now estimating cash flow from operating activities of $10.3B in 2019. If I apply the company's FY2018 FCF conversion estimate of 90% to FY2019's cash flow from operating activities, then I estimate that the company would generate $9.27B in FCF.

Source: SimplyWall.St

If the company maintains a similar FCF payout range in FY2019 as well and no share repurchases, the dividend payments would increase to $5.5B to $6.4B or $0.63 to $0.74 per share annually. This would represent an increase of 31.3% to 54.2%. Honestly, this seems incredibly unrealistic based on where the company is and what has just occurred. Even if the dividend was raised according to the growth in FCF year over year, this would still represent an increase of 42.6% which is in the middle of my estimated range which I still believe is unlikely for this company.

What this means is that I believe that the company is going to watch its cash flows and not pay out more in dividends than it has in FCF. So, this means that an analysis of GE's peers may provide a clearer picture of GE's future dividend.

I have selected Carlisle Companies Inc. (CSL), Honeywell (HON) and 3M (MMM) to represent GE's peer group.

The following table presents a comparison of some of the key metrics described by GE's CEO as being key indicators for GE's future dividend.

GE

HON

CSL

MMM

Current Dividend Yield

5.43%

2.00%

1.34%

2.01%

5YR Average Yield

3.2%

2.0%

1.2%

2.3%

Current EPS Payout Ratio

117.2%

39.8%*

27.9%*

50.5%*

Current FCF Payout Ratio

278.1%†

66.1%*

46.8%*

80.8%*

Estimated Year End FCF Payout Ratio

278.1%†

45.5%

26.4%

57.2%

1YR Dividend Growth Rate

4.3%

14.1%

18.2%

8.3%

3YR Dividend Growth Rate

5.6%

13.4%

15.7%

20.5%

5YR Dividend Growth Rate

9.1%

12.3%

13.2%

15.1%

10YR Dividend Growth Rate

-1.3%

10.4%

9.6%

9.2%

Source: Old School Value, David Fish CCC list, FCF payout ratio calculated using information gathered from each company's third-quarter earnings presentations.

* These companies have reported only three quarters. These ratios are likely to change due to changes to the addition of their fourth quarter.

† GE's estimated free cash flow of $3B was used in this calculation.

GE's future annual dividend of $0.48 would represent a forward yield of 2.3%, which is still slightly above its peers but does place GE within its peer group. The FCF payout ratio is also within its peer group with an estimated ratio between 60-70% right now but HON, CSL and MMM have not reported all four quarters yet. My estimates show a year-end FCF payout ratio that GE's FY2018 FCF payout ratio would still be higher than its peers. Finally, the EPS payout ratio, estimated to be between 44.9% and 48.0%, places GE in the middle of its peer group.

Where GE is likely to have issues in keeping up with its peer group is in growing the dividend. HON and CSL continue to raise their dividend by double-digits, something GE has not done since 2014. I should also note that HON and CSL have increasing proportional growth rates, not decreasing like GE and many other dividend growth stocks. A difficult feat to pursue. MMM's dividend growth is not nearly as impressive as it looks. A closer inspection reveals that there were two large increases in 2015 (20%) and 2014 (35%) that are skewing the growth rates which would otherwise have averaged 6.8% over the 10-year period prior to these increases. GE may very well follow MMM since many of the metrics above are similar.

If GE followed MMM's average dividend increase of 6.8%, that would mean that GE's dividend would rise to about $0.51 which would represent a 47.8% FCF payout ratio in FY2019. This seems reasonable and places GE in the middle of its peers at the moment. This is higher than GE's median $0.02 dividend growth over the past 19 years. If GE resumed its median dividend increase of $0.02, then GE would raise its dividend by 4.17% and have a FCF payout ratio of 46.9%. This is assuming of course that GE can actually achieve its FCF estimates.

Can GE Keep Up?

Although things look good for GE in terms of FCF generation and coverage for the dividend with potential for future growth, GE will face continued pressure going forward due in part to its $31B underfunded pension plan. GE announced that it will be taking on $6B in debt in 2018 in order to pre-fund the company's pension plan through to 2020. However, this only kicks the underfunded pension plan issue further down the road.

GE is also awash in debt. GE is the guarantor of GE Capital. Combined, the company has over $136.4B in various forms of debt. GE has done an excellent job of decreasing that debt over the years as shown in the chart below, but the company is planning on adding more debt and has less cash to pay off this debt particularly as it attempts to restructure itself. Selling assets could assist in paying this off further.

Source: SimplyWall.St

GE's debt maturities over the next 5 years are greater than the FCF that the company is generating or estimated to generate. The company does plan to refinance its debt but once again, it is kicking the can down the road in hopes that the company successfully implements its turnaround strategy.

Source: GE 2016 annual report, chart created by the author

One added advantage for HON, CSL and MMM is that their share buyback programs are ongoing and are likely to continue to reduce the float of outstanding shares. GE, on the other hand, has said that it will buy back shares "where it makes sense" (source). This will prevent GE from exploiting one area that could have an impact on the amount of dividends paid as well as improving its payout metrics. Even at this time, with share prices at depressed levels, the company does not plan to take advantage of this opportunity.

HON, MMM and CSL are currently running efficient operations. These three companies have free cash flow conversions between 95-100% while GE, having aspirations of achieving 90% FCF conversions in FY2018, is currently converting between 50-65%. There needs to be a great deal of improvements in GE's operations in order to achieve this and it is unlikely to occur within one year.

Lastly, GE Capital has supported a big portion of the company's dividend. But GE Capital has been divesting assets which provides short-term capital from sales but no lasting or recurring revenues. GE mentioned in its presentation that it deferred taking a $3B dividend from GE Capital in 2H 2017. The company also stated that it will not take a dividend from GE Capital in 2018. This means that potential sources of funding for the future dividend will not be accessed.

Final Thoughts

There remain a number of issues facing GE moving forward. Half of GE board of directors is set to depart which could be positive and negative. Activist investors may attempt to move in like they did with Procter & Gamble (PG) during its restructuring. Moody's expects severe deterioration in GE Power for several years (although GE just signed a $400M contract with Iraq). If this is true, this is one of the segments that GE of the future will be comprised of. GE may be looking to sell off its oil and gas segment since it does not seem to have a place in GE's future, but with oil prices still down (but climbing slowly), a potential buyer may not be found so quickly or GE may get little in return. The transportation market remains soft and has been a drag on revenue and operating profit. The drag on GE's core segments and expendable segments may make this turnaround slower than expected, which would then suggest that the dividend growth is low or non-existent.

There is a lot of pessimism by analysts and investors at the moment. Some question whether the company's plan will be enough to help turn GE around, while others say the company is still too complicated. For me, there are too many questions regarding what the dividend policy will be going forward. The first cut is the deepest and a shame on it while the second cut is a shame on me. Nothing at this time suggests that the dividend is likely to grow and could be cut once again should the turnaround fail.

I think dividend growth investors should have pessimism in this company regarding their dividends. When Mr. Flannery took on the role of CEO, he stated that the dividend was safe but we know what has happened since. Regarding the dividend, there are continued references to "healthy dividend," "where it makes sense" and "we'll see how it goes." These references always include the dividend along with share buybacks, M&A, and organic investment. It raises doubts in my mind that the dividend will ever be "safe" again and it might not be raised if things don't go well or it doesn't make sense. Lumping the dividend with all other considerations to me states that the dividend remains on the table as a cost-cutting option.

I was disappointed that Mr. Flannery did not elaborate on the company's thought process in cutting the dividend. If management was so optimistic about the company's ability to return to turnaround, why didn't it make a "token" increase of $0.01 or $0.02? Assuming no further changes in share count and GE actually attaining a 90% FCF conversion, I estimate that the FCF payout in 2018 would have been around 91%. Such increases could continue until its desired payout range was achieved. Alas, the management was not so forthcoming, and this leads only to speculation of what could have been. Nevertheless, I believe that a token increase like PG had done would have preserved shareholder value rather than diminished it. The company did not provide any information how the $4B in savings from cutting the dividend would be used to help the company. This lacks a level of transparency that I believe all investors affected by this cut should have received.

All that being said, I don't see GE as a sleep-well-at-night type of dividend investment, and I have lingering doubts that GE will be a dividend growth stock in the short to mid-term. As a result, I would not be adding GE to my portfolio.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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