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Industrial giant General Electric plans to cut its dividend once more in order to accelerate deleveraging, and it also will split its ‘Power’ business into two units. We’ve cut our fair value estimate for shares following the strategic update and earnings report.
By Kris Rosemann
Prior to its earnings release and strategic update before the open October 30, General Electric’s (GE) Dividend Cushion ratio was 0.1, which brought with it very poor Dividend Safety and Dividend Growth ratings, even after it halved the payout in late 2017, as its industrial operations were not able to generate enough cash flow to sustain a healthy payout. Management now plans to reduce its quarterly payout to $0.01 per share from the current rate of $0.12 per share upon the Board of Directors’ next dividend declaration, likely in December, and it expects this reduction to save the company roughly $3.9 billion in cash per year. This cash will be used to shore up the balance sheet as management targets a net debt-to-EBITDA ratio of 2.5x and a sustainable credit rating in the single A range. Over time it will look to achieve a dividend payout ratio in line with peers.
GE also plans to reorganize its struggling ‘Power’ business into two units, one of which will combine its gas product and services group and another made up of its steam, grid solutions, nuclear, and power conversion assets. It will also consolidate the collective business’ headquarters structure, and the moves are intended to improve cost structure, enhance execution agility, and deliver better outcomes for customers and investors. The company expects to “significantly miss our full year cash flow and earnings targets” for 2018 as a result of issues in its ‘Power’ business now expected to persist longer and with more significant impact than initially expected.
While GE’s strategic decisions stole the headlines, it also reported lackluster third quarter results October 30 as total industrial segment revenues fell 5% on a year-over-year basis due in large part to ongoing weakness in its ‘Power’ business. Its ‘Aviation,’ ‘Oil & Gas,’ and ‘Renewable Energy’ segments were all sources of top-line strength as they grew revenue 12%, 7%, and 15%, respectively from the year-ago period. The ‘Aviation’ segment was a bright spot in terms of orders and segment profit as well, which grew 35% and 25%, respectively, on a year-over-year basis and led the company in terms of segment growth rates, aside from the ‘Transportation’ segment, which is on track to be combined with Wabtec (WAB) by early 2019. Overall, the company’s industrial backlog grew 6% from the year-ago period to $378.9 billion.
GE’s reported bottom-line results were decimated by the recording of a non-cash goodwill impairment charge of roughly $22 billion, pre-tax, related to its ‘Power’ business, more specifically mostly related to the poorly-timed Alstom acquisition of late 2015. Continuing earnings per share checked in at negative $2.63 compared to $0.16 in the comparable period of 2017, and adjusted earnings per share fell to $0.14 from $0.21. Adjusted GE industrial profit margin fell nearly two full percentage points from the year-ago period to 8.1%, and GE cash flows from operating activities came in at negative ~$3.4 billion in the quarter, compared to $465 million a year earlier. Adjusted GE industrial free cash flows fell 5% in the quarter on a year-over-year basis and remained in negative territory for the year-to-date period. The company held total borrowings of nearly $115 billion at the end of the third quarter, roughly $47 billion of which was held by GE Capital.
GE also disclosed a probe of its accounting practices by the US Department of Justice, which comes in addition to an expanded investigation from the SEC. The DoJ is said to be looking in to the recent $22 billion impairment charge related to its ‘Power’ business, as well as the $6 billion charge it took in the first quarter of 2018 related to insurance reserve shortfalls. These charges are also the focus of the recently expanded SEC investigation.
Shares of GE have faced substantial pressure in recent years, and the amalgamation of negative headlines alongside its third-quarter report only added to the pain. The company’s credit ratings have been placed on review for downgrade by Moody’s and Fitch, and S&P downgraded its credit rating to BBB+ from A in early October. We’ve lowered our fair value estimate for GE as a result of lowered near-term expectations, and its Dividend Cushion ratio now sits firmly in negative territory due in part to materially lower near-term free cash flow expectations.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.