General Electric (GE) announced its CEO Jeff Immelt is stepping down on August 1 and will retire from his role as chairman of the board at the end of 2017.
Immelt had served as GE’s CEO for 16 years and wasn’t exactly the most popular executive with investors, to put it nicely.
Questionable capital allocation decisions, the dividend cut during the financial crisis, the lack of capital returned to shareholders, bureaucracy, and non-GAAP accounting complexities are all reasons why GE has been one of the most unloved stocks in America.
In fact, shares of GE have seen their price decline by more than 30% since Immelt succeeded Jack Welch at the end of 2001.
Immelt will be replaced by John Flannery, a 30-year GE veteran with experience running GE Healthcare, overseeing the large acquisition of Alstom, managing GE’s operations in India, playing key roles at GE Capital, and more.
Let’s take a closer look at GE’s leadership change to evaluate what it means for long-time dividend investors and the company’s dividend safety.
Prior to this announcement, GE’s stock had drifted lower by close to 12% year-to-date, trailing the S&P 500 Index by about 20%.
Investors were frustrated by the company’s weak cash flow generation in the first quarter, Immelt’s recent comments that GE’s 2018 earnings per share target might be out of reach, and weakness in the important oil & gas market.
As a result, GE’s shares were trading at a forward P/E ratio of 16.9, representing a discount to the broader market (17.7 forward P/E) and reflecting lowered expectations.
When combined with investors’ pent-up frustration with Immelt, it’s not much of a surprise to see GE’s stock reacting favorably to the news, climbing by more than 3% in early trading.
However, one effective dividend investing habit is to never make a decision based solely a stock’s short-term price performance. Instead, an investor should decide if the news actually impacts a company’s long-term future and whether that development appears to be fully priced into the stock.
After all, the short-term rise in a stock’s price could be just another overreaction by the market to an event that really doesn’t matter.
Is This Noise or News?
A CEO transition is a big deal. The CEO is in charge of guiding a company’s overall strategy and capital allocation decisions, which can significantly affect the long-term path of a business and the value it creates for shareholders.
GE says that its CEO transition process was set in 2011, so today’s news probably shouldn’t have come as a huge surprise; however, the timing of the transition away from Immelt was likely a bit sooner than many investors expected.
Incoming CEO John Flannery seems unlikely to really rock the boat at GE since he has been with the company for three decades and served in leadership roles that are largely aligned with the company’s current strategic direction (e.g. shedding GE Capital, acquiring Alstom).
I don’t view this change in leadership as a reason to go out and buy GE’s stock, but I think it’s an overall positive for the company as it works to get the most from the business transformation it’s gone through over the last five years.
With that said, there is a lot of room for GE’s new CEO to begin restoring credibility with investors by instilling more financial discipline (especially on cash flow), unlocking the value of GE’s world-class industrial assets, and executing better on activist investor Trian’s profit improvement plan.
However, given GE’s massive size and slow-moving nature, it could take at least a couple of years for any changes Flannery makes to begin bearing fruit.
There are also many examples of new CEOs “clearing the deck” by slashing guidance shortly after taking the helm in an effort to keep expectations low.
Given Immelt’s recent shakiness around the company’s ability to meet its 2018 earnings-per-share target and continued challenges in the oil & gas market, I wouldn’t be surprised if Flannery resets or removes GE’s 2018 earnings goal later this year.
This wouldn’t matter much for long-term investors (if anything it could prove to be a timely buying opportunity), but it could negatively affect the stock’s short-term performance and possibly result in more concerns about GE’s dividend.
Is GE’s Dividend Safe?
Some investors began to worry about GE’s dividend safety earlier this year when the company’s first-quarter cash flow missed guidance by $1 billion (for comparison’s sake, GE’s annual dividend payments total about $8 billion, so it was a large miss).
Deutsche Bank analyst John Inch published a bearish note on GE shortly after it reported earnings and suggested that the company might have to eventually cut its dividend given the weak cash flow performance.
Here’s a highlight from his note:
“Per GE’s cash guidance of $27bn (CFOA) in 2017-2018 (total $25-29bn), this implies $13bn CFOA (midpoint target this year) and $14bn next year. After subtracting capex of ~$3.5bn and required pension of ~$1.8bn/yr for 2 years, FCF of $7.7bn in 2017 would fall short of the required ~$8bn of common dividend funding and just above next year. Note, too, that $7.7bn would equate to roughly 85 cents of free cash flow this year and roughly $1.00 in 2018. However, GE pays out 96 cents in annual dividend, or significantly more than the 85 cents of 2017E Industrial FCF and roughly in-line with the $1.00 in 2018E. Considering that proceeds from Capital dismantlement and asset sales eventually go away, this high dividend payout would not appear sustainable…
We believe the stage is being set for GE to cut its common dividend, likely as part of an earnings “reset” lower and possibly in conjunction with eventual future leadership change.”
Executive leadership changes can sometimes result in major capital allocation changes too, including the amount of dividends paid.
However, I believe GE’s dividend will likely remain safe with moderate growth potential going forward. The company maintains a Dividend Safety Score of 58, which suggests GE’s dividend is very close to the “Safe” bucket and has a rather low risk of being cut.
Investors can learn more about Dividend Safety Scores and view their real-time track record here.
Starting on the cash flow front, scrutinizing a three-month period of time is a bit short-sighted. Almost anything can happen in 90 days, especially for a business that manufactures and sells expensive pieces of industrial equipment.
GE’s management noted that the first-quarter cash flow shortfall was driven by a build up of working capital to support growth and several one-time items, which are expected to reverse in the second quarter.
Management also reaffirmed full-year cash flow guidance and shot back at Deutsche Bank’s report by subsequently issuing the following statement:
“The Deutsche Bank alert is totally wrong – the analysis is faulty. The GE dividend is safe. We will generate $12-14B of cash flow from operations this year and we have $8 billion in cash on our balance sheet as of the end of first quarter. In addition, we just did an investor presentation at EPG where Jeff outlined that we will buy $11-13 billion in stock back this year and we have $8-12 billion unallocated cash in our framework. We clearly stated that the dividend remains a priority – we would prioritize