On September 20, 2018, General Electric's (NYSE:GE) stock was under pressure after a well-known JPMorgan analyst, Stephen Tusa, lowered his price target for the struggling conglomerate from $11 to $10 per share.
Mr. Tusa outlined his near- and long-term concerns for GE's Power unit and stated that he is concerned that the company's financial and fundamental risks may not fully be factored into the stock price.
As a long-term shareholder, this downgrade is concerning, especially when you consider the fact that it came from a bear that has consistently been right on his GE calls over the last two years. More importantly, however, Mr. Tusa's investor note instantly brought me back to the thoughts that I outlined in "GE: The Other Shoe Should Drop Soon" - i.e., GE's dividend should either be entirely cut or at least reduced to a more-manageable amount (a dividend yield well-below 2%).
If GE cut its dividend, I believe that the stock would face downward pressure but, in my opinion, it would finally be a step in the right direction. At the end of the day, I plan to stay long the stock but prospective investors should seriously consider the main risk factor before putting new money to work in GE.
GE maintaining its rich dividend is a risk that investors need to start baking into the equation. In this CNBC interview, almost every analyst on the desk agreed that there is no reason for GE to be paying such a healthy dividend. Moreover, there is a large number of pundits that believe that GE shares are being weighed down by the prospects of another dividend cut.
Simply put, I do not believe that GE should be paying an almost 4% dividend. The company's current dividend yield is almost twice the average yield of its peer group.
In my mind, it is hard to make the argument that GE should be paying an above-average dividend during a period of time when the company's largest operating unit (Power) is facing significant headwinds. Remember, the Power unit's operating results are down big over the first six months of 2018.
Source: June 30, 2018, 10-Q
Management's commentary related to Power's future business prospects is cause for concern, too:
...Power remains challenging. First half trends continue to point to a market less than 30 gigawatts in 2018, which is down from 34 gigawatts last year and 48 gigawatts in 2016. We are planning for the environment to be in this range through 2020.
...For the year, the continued challenges we are seeing in power are putting pressure on our total year adjusted industrial free cash flow outlook.
...it’s clearly our top priority, is managing through and fixing our issues in the Power business. So, we’re working that intensely, in total sense of urgency. The market is challenging, but we need to work through that. It’s going to be a multiyear fix, I think with some volatility. This is not something that’s going to move straight line quarter-to-quarter.
Source: Q2 2018 Conference Call
Additionally, the recent issues with four U.S. power turbines only adds fuel to the fire. Let's also not forget that the company is in the midst of major restructuring efforts - Wabtec (WAB) deal, Healthcare spin, and an eventual Baker Hughes, a GE Company (BHGE) separation - that will eat up a tremendous amount of capital over the next 18-24 months. And this list does not even include GE's large pension deficit (a topic that was recently covered by another SA author in this article).
To this point, GE's cash flow metrics are stretched and there have been no real signs that the next two quarters will be any better.
Source: Q2 2018 Supplemental Report
As shown, GE's GAAP and Non-GAAP cash flow metrics are deep in the red over the first six months of 2018. Plus, the company has a debt balance that is somewhat alarming given the current state of the company.
Source: June 30, 2018, 10-Q
Mr. Flannery, CEO, and team have already made progress toward reducing GE's financial leverage but, again, I question why the company should continue shelling out much needed capital. The management team currently has an out and, in my opinion, they could remove a significant overhang by reducing the dividend to a manageable amount. I do believe that the company has the cash and investments on hand to service the dividend, at least for the time being, but that does not mean that it would be a prudent business decision to keep the almost 4% yield.
The Tusa call is a prime example of GE shares being significantly impacted by sentiment and other factors that are outside of management's control. Looking back, headline risk has played a large role in the stock falling from the high teens to current levels. And yes, the company's lackluster earnings results did not help either.
Over the last year, investors have had to contend with major management/board changes, a 50% dividend cut, lowered 2017 guidance, billions of dollars in non-cash charges (pension & long-term care), SEC investigations, and lowered 2018 guidance. So, investors should not be surprised that the stock is down approximately 50% over this period of time.
Makes sense, right? However, investors are now asking if everything is priced into the stock. It pains me to say it but it is impossible to know if everything is already priced in because shareholders simply do not know what is coming next. On the other hand, GE's stock is indeed trading a steep discount to its peer group.
GE shares are at attractive levels but the company cannot seem to get out of its own way. It is likely going to take the Power unit years to fully recover and the other concerns (i.e., pension, potential Alstom charge, long-term care business, and SEC investigations) will weigh on the stock in the quarters/years ahead.
So, the stock is trading at attractive levels but that does not necessarily mean that investors should put new money to work in this storied company at this point in time.
As I recently described here, GE is a 3-to-5 year story. GE has plans to spin off its Transportation and Healthcare units, and the company has already been selling off other non-core assets, so I believe that management is doing what is necessary to right the ship. It will take Mr. Flannery and team time but it is important to note that these risks are being priced into the stock.
In my mind, a dividend cut would remove a major overhang for the stock. Yes, investing in GE today is risky, as there are a lot of moving pieces to factor in, but this industrial conglomerate has great assets/businesses in its portfolio if your time horizon is longer than 12-24 months. As such, long-term investors should closely monitor GE and pull the trigger if shares hit Mr. Tusa's new price target of $11.
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, 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.