General Electric (GE) held its Investor Day earlier this month and the event was shocking to say the least. First of all, with the company’s myriad of challenges I was shocked management found time to even meet with investors. The company missed on Q3 earnings and the stock has fallen over 20% since. I would have expected management to keep its nose to the grindstone to help right the ship.
The other shocking occurrence was the company’s admission that its dividend pay out of $0.96 per share ($8.4 billion) exceeded GE’s free cash flow for years. Why was this issue never raised by analysts or previously disclosed by management? The fact that analysts or the investment community never picked up on this issue (1) proves how little we understand of the company and (2) the danger of GE’s opaqueness. In my opinion, the company has been a puzzle for years. The fact that it has gotten away with such a lack of transparency is even more alarming.
GE cut its 2018 dividend in half to $0.48 per share. The dividend yield is now in the range of 2.3%. Management expects it to equate to 60% – 70% of free cash flow. Optically it looks bad that a company with a reputation for financial soundness has to cut its dividend. Dividends upstreams from GE Capital will likely be limited, and it might have forced GE’s hand. About 40% of GE’s shareholders are retail investors who depended on that dividend. Investors now have to depend more on capital appreciation from what appears to be a rudderless company.
Below are additional observations on GE’s investor presentation and the future direction of the company.
M&A – A More Disciplined Returns-Approach?
Under former CEO Jack Welch GE was known for spotting trends and investing in them before they became apparent to the rest of the market. Acquiring companies that met GE’s return requirements and performing strong due diligence on targets were GE’s core competencies. GE made $34 billion worth of acquisitions from 2013 – 2017. I expected to hear how M&A would be a major driver of growth, but that did not happen.
Instead of making bold strokes the company talked of the need for smaller bolt-on acquisitions. Management also voiced the need for a more analytical assessment process and a more disciplined returns-approach for evaluating investments. Being discipline about financial returns was once part of GE’s DNA. If GE has gotten away from being disciplined pursuant to M&A then it likely explains its $10 billion foray into the oil & gas sector, which was a major misstep. It could also connote that GE is now just like any other company. Therefore, any market premium it might have commanded due to a disciplined, focused management team could dissipate.
Cost Outs Will Likely Drive GE’s Bottom Line
I walked away from the company’s Q3 earnings call with the notion that GE would wring a lot of costs out of the business. While top line growth could be uneven, bottom line targets could be met or exceeded depending on how much costs management can wring out. GE expects $2 billion of cost outs in 2018, the lion’s share of which will come from Power and Aviation, and Baker Hughes, a GE Company (BHGE) which GE owns a 62.5% stake in.
Power was a disappointment in Q3. At 29% of total industrial revenue it is GE’s largest segment. Revenue fell off 4% Y/Y, while segment profit was off 51%. Management expects to face headwinds in Q4 and into 2018:
We have severely disappointed with the result of power and are taking actions to position the business going forward. This includes a refocus on the basics, significant additional cost out plans and changes to management including announcing a new Head of Power Services this week. The business has been undergoing market changes and we haven’t changed fast enough with it. The market demand for heavy duty gas turbines declined to 40 gigawatt this year down from 46 gigawatt last year. The structure of the service market has also changed as we discuss on the second quarter conference call driven by renewables fleet penetration for AGP, lower capacity payments, utilization and outages. However, the decline we saw in our services business in the third quarter was much sharper than the decrease in the first half.
The segment powers 30% of the world’s power. If Power is slowing then that likely means the global economy is also in a down cycle. When GE shuttered GE Capital it made a bet on the cyclical nature of manufacturing and the vagaries of the global economy. If the global economy is in a downtrend then Power will likely slow regardless of any changes to senior management.
The merger between Baker Hughes and GE’s oil & gas segment was expected to create scale and cost synergies. The merged entity was expected to generate $14 billion in revenue in the second half of 2017. GE reported Q3 2017 revenue of $5.3 billion for the segment, and it is trending below what was previously expected. The merger was also expected to yield about 1.2 billion in costs synergies by 2020 when its revenue was projected to be around $34 billion.
GE still expects $1 billion in cost outs for BHGE by 2020, but can it get there if the business falls shy of the $34 billion in revenue previously projected? If not, when will the company ratchet down its cost out expectations?
Conclusion
GE’s operations remain as clear as mud. The top line could be choppy amid an uncertain global economy, and potential changes to what is and is not considered “core” to the company’s operations. Cost outs could help the company meet quarterly earnings but the quality of its earnings could become suspect. At over 20x earnings GE is still not cheap. Until it shows consistent revenue and earnings growth GE remains a sell.
Trump And The Global Economy
The second installment of Trump And The Global Economy Town Hall took place October 24th in Fort Greene. It Featured Professor Lance Brofman, Coconut Rob (Coconut Rob Smoothies), Wuyi Jacobs (AfroBeats Radio) and Ralph Baker, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead.
The event was well-received by the community. We parsed through President Trump’s proposed tax plan and [i] how it was pure economic folly and [ii] high net worth individuals could potentially game the system by shifting income around. Apparently, Kansas Coach Bill Self did this when the state of Kansas cut taxes in the past. We discussed the pros and cons of technology on workers and the economy. How will the economy and country prosper under Trump’s leadership vis-a-vis Obama? What’s behind the verbal sparring with black athletes, ESPN’s Jemele Hill and North Korea’s Kim Jong Un?
