Business

The Lessons Of General Electric’s Dividend Cut

The dividend cut that has been expected finally happened. General Electric announced it is cutting its dividend in half, a move that could cause many long-time shareholders in the 125-year-old conglomerate to flee but also free up much-needed capital to fund a turnaround for the one-time American bellwether. CEO John Flannery says the decision was difficult but necessary in light of the company’s efforts to find the best ways to use its cash. GE has paid a dividend since 1899 and has only cut it twice: in 1939 and in 2009. Obviously the market didn’t react well. How ugly has the recent dive in General Electric’s stock price been?  Richard Peterson, principal analyst at S&P Global Market Intelligence, notes that since the Nov. 8, 2016 election, GE has lost over $100 billion in market capitalization based on today’s prices at mid-day.  That exceeds the total current market capitalizations of FedEx Corp., Moody’s Corporation, and BorgWarner, Inc. combined.

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Among other expected changes to the company are:

  • A focus on three of the company’s prime business lines — aviation, power and health care. GE said it is looking to exit more than $20 billion of assets.
  • While it slashed its dividend in half, the company also set a $3 billion share buyback priority.
  • Addressing its pension plan shortfalls, Flannery said the company will borrow $6 billion to take advantage of the current rate environment.
  • The board of directors will be reduced from 18 to 12, with three new members slated “with relevant industry experience.” Directors will have 15-year term limits.
  • Employee bonuses also will be restructured, with elimination of the three-year cash long-term performance awards and a switch to a program that conforms to “market norms.”
  • Slice 25% of staff from its home office

There hasn’t been a word on GE’s stake in oil and gas operator Baker Hughes (BHI), which became a separate publicly traded company in July after it merged with GE’s oil and gas operations.

So what happened?

Since the financial crisis GE has shrunk but not its dividend. In the last five years, the industrial cash flow of GE has not covered the dividend. That was fine previously when you had GE Capital there to pay its fair share. But with GE Capital gone, there’s just no way to pay the dividend. The payout was unsustainable. Before the cut, the market drove GE’s yield all the way to 4.7%, the 2nd highest in the Dow after Verizon (5.3%). The new dividend yield will be 2.3 percent. Below is a chart of the companies with the biggest cash dividend payout:

General Electric's Dividend Cut

GE’s free cash flow, or the level of cash flow less capital expenditures, had contracted to about $7 billion, about half its normal level.  GE and the Street were expecting $14 billion for year. Its dividend cost $8 billion. The 50% dividend slash is expected to generate $4 billion in cash annually.

The issues have probably been lingering for a while and have recently been reflected in the share price. GE even raised its dividend last year, that’s how confident they were. GE’s performance and its returns have been bad. But without this unpopular difficult decision they would have been worse in the future. Of course they are no guarantee that the turnaround will be successful. In a way I feel this company has been restructuring even since Jack Welch has left. The shareholder pain has been real for many years. Two years ago GE was talking about reaching $2 in EPS. Now GE said it now sees adjusted earnings for the year ahead of between $1 per share and $1.07 per share. You should also expect $6b-$7b in free cash flow.

GE will be smaller, simpler, and more focus. If things work out, this should drive stronger growth and create more value for shareowners.

Lessons

GE had the reputation of a must own stock. It was a classic blue chip. You couldn’t go wrong with GE in your portfolio. Although its performance has been lagging for years now, it was still considered a classic blue chip. It was just a matter of time before the giant industrial came back. A lot of retires were dependent GE’s dividend. The dividend was religious. You couldn’t touch it because it would kill your shareholder base.

The lessons here is that you can’t be dependent on one company. Even if the company is a blue chip and has been paying dividends for over 100 years, it’s very important to have a portfolio of high quality assets.

Article by Brian Langis