General Electric: The Other Shoe Should Drop Soon

Summary

• This company was recently booted from the Dow, so what should investors expect to happen next?
• Analysts are calling for General Electric to suspend its dividend and I actually agree with these calls.
• I have an overweight position in General Electric and I plan to stay long the stock.

What a month! So far, June 2018 has not been kind to General Electric (NYSE:GE) or its shareholders, as the stock is currently sitting around $13 per share and is down almost 15% over the last month.

GE data by

YCharts

To add injury to insult, GE was also recently booted from the Dow Jones Industrial Average after being apart of the index for over 100 years. How could things possibly get any worst? One thing comes to mind when I think about this question - another dividend cut. I fully expect for General Electric to slash its dividend again but, as a long-term investor, I believe that a dividend reduction would eventually be a positive catalyst for the stock.

Would A Dividend Cut Actually Be A Positive For GE And Its Shareholders?

Goldman published an investor note that called for GE to "suspend" (try not to laugh about the use of "suspend" instead of "cut") its dividend for 18 months. It pains me to think about one of my long-term investments cutting its dividend, especially after it just recently reduced the payout by 50%, but I believe that a more sustainable dividend would eventually be cheered by the market.

At the end of the day, Mr. Flannery really needs to consider if it still makes sense for GE to be paying an above-average dividend while the company is in the midst of major restructuring efforts while also contending with a stretched balance sheet and a credit rating is close to junk status.

Company	Dividend Yield
GE	3.76%
HON	2.07%
UTX	2.24%
MMM	2.77%
Average	2.71%

Click to enlarge

Source: Yahoo! Finance

Ask yourself, why does an industrial conglomerate that has cash flow pressures have a dividend yield that is twice its closest peer? The table speaks for itself, of course, in my opinion, but this is one of the main reasons why I believe that GE should cut its dividend - i.e., better run companies, that are not dealing with the same type of issues that GE is, are more than content with their average dividend yields. If anything, this is Mr. Flannery chance to reset expectations and establish a dividend that is actually sustainable over the long haul. Yes, he should have done it several months ago (the dividend should have been slashed by more than 50% in November 2017) but, as the old saying goes, better late than never.

Moreover, let's also keep in mind what GE's dividend is 'costing' the company. As shown below, Mr. Flannery and team expect for GE to record $6B-$7B in adjusted industrial FCF for 2018.

Source: Investor Meeting, April 2018

To kill two birds with one stone, let's take a look at GE's Q1 2018 adjusted industrial FCF to review the results for the most recent quarter in addition to get a feel for what is included in the calculation.

Source: Q1 2018 Supplemental Document

The company had a rough Q1 2018 from an adjusted industrial FCF standpoint (better than the same period of the prior year but still a tough quarter) but, again, the company still expects to report a mid single-digit number for the full year. However, and more importantly, I think that management should ask themselves two critical questions: [1] why should a company that is projected to report negative cash flow metrics (i.e., non-adjusted GAAP measures) for the 4th year in a row still have a dividend yield of ~4%?, and [2] is there currently a better use for the approximately $4B of capital that will be paid out in dividends in 2018?

GE could use the $4B to fund investments (e.g., PP&E additions, small tuck-in acquisitions, etc.) while at the same time paying down its large debt balance. The current dividend translates into over 50% of the projected adjusted industrial FCF for 2018 - the dividend is not included in the calculation but you get my point - so this company without a doubt has other uses for this capital (even if it is only $4B).

If Mr. Flannery honestly answered the two questions above, I believe that GE would have a dividend yield of around 2% (or lower). In my opinion, it would be a prudent business decision for Mr. Flannery to reduce the dividend [again] and try to turn the focus to the company's businesses that have promising long-term prospects.

Keep The Long View In Mind

There is a great deal of uncertainty when it comes to GE and its future state, but we do know a few things:

1. Management recently reaffirmed their full-year 2018 guidance and expects for the company to significantly improve its operating results in the second half of 2018.
2. GE lowered its pension deficit by 8% in 2017 and the current rising rate environment, in addition to the pre-funding contributions committed through 2020, will put this company in a better position in the years ahead when it comes to its funding status.
3. The company will spinoff its Transportation business in a unique transaction with Wabtec (WAB) in a deal that is valued at about $11B. The Transportation announcement comes after several other smaller deals so it definitely appears that management is trying to achieve the goal to sell/dispose of $20B of assets over the next few years.

It is encouraging that GE is making an concerted effort to get its pension funding status to a better position but, more importantly, I think that the Transportation deal shows that management is serious about creating a simpler, more-valuable company sooner rather than later. I look forward to holding a position in the soon-to-be newly created Transportation company and, if the recent rumors are true, GE shareholders should expect for additional spinoffs to be announced in the near future.

As I described in a previous article, my 'dream' transactions for GE would be for the company to:

• Sell (or spin off) Transportation and Lighting (Transportation is a done deal!)
• Spin off Baker Hughes, a GE Company (NYSE:BHGE).
• Spin off Healthcare - it pains me to say it, but I believe that this business is more valuable as a standalone company, which is also the reason why I want the unit to be spun off instead of sold.

All of this comes back to the potential dividend cut. Yes, GE will be blackballed by some investors (including some institutional investors) if the company cuts the dividend again but, in my opinion, the potential benefits when it relates to having the needed capital to truly create a 'new GE' would far outweigh the negatives of losing part of its investor base.

Risks

The main risk for investing in General Electric starts with management. There is no guarantee that Mr. Flannery is the right man to turn around a company that is widely viewed as a directionless, complex industrial conglomerate. Sentiment is the number one factor for GE shares being down by almost 50% in 2017, so shareholders are putting a lot of faith in a largely unproven leader, at least on this type of stage.

The SEC probe/investigation has the potential to be a game changer for this company. The fine is not the issue, but instead, what else the SEC will find is the real concern. Has GE been fudging its numbers for years? How exactly did the Power unit's profit fall so far so fast? GE stock will face further downward pressure if the insurance charge probe results in the SEC looking deeper into the company's past earnings results/disclosures.

Bottom Line

In my opinion, it is almost impossible to truly value General Electric's stock at this point in time because there are entirely way too many moving pieces. My investment thesis has been busted for quite some time but I plan to stay long the stock simply because I am a long-term believer of several businesses that are under the GE umbrella. First, GE Healthcare and Aviation alone accounts for most (if not all) of the current market cap for GE so a spinoff would unlock a tremendous amount of value. Additionally, I personally believe that a Baker Hughes spinoff is long overdue and, in my opinion, it would be a win-win situation for the shareholders of both companies. Lastly, the Renewable Energy division does not get enough attention but I believe that this unit is a hidden gem.

A dividend cut is never ideal but, in my opinion, Mr. Flannery should seriously consider reducing the payout in the near future. GE cutting its dividend would almost certainly add fuel to the fire as it relates to the downward pressure for the stock but, in my opinion, a reduced payout would actually turn out to be positive over long-term.

Investing in GE today is risky and there are a lot of moving pieces to factor in, but, in my opinion, GE has great assets/businesses in its portfolio if you are willing (and able) to hold onto your position for the next three to five years. As such, long-term investors should consider further pullbacks as buying opportunities.

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.

Disclosure: I am/we are long GE, BHGE, HON, UTX. 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.