Could GE’s Dividend Cut Point to Financial Crisis Ahead?
Confidence in corporate earnings visibility was shaken this morning as American industrial and financial mega-conglomerate, General Electric Company (NYSE:GE) said it was slashing its dividend by half. The $0.12 payout of each share (down from $0.24 previously), marks the lowest gross dividend since 2010, when America was just starting to recover from the Great Financial Crisis.
Is this shocking development company-specific or a harbinger of things to come for Corporate America? The importance of this question for investors cannot be understated. After all, General Electric is one of the oldest components of the Dow Jones Industrial Average (DJIA), and among the most iconic American corporations around. If GE is experiencing cash flow issues, could other industrial giants follow? We examine.
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General Electric Halves Dividend, But Why?
Stock market bulls are undoubtedly a little nervous this morning. With the market entrenched on a historic multi-year bull run, it wouldn’t take much to upset the apple cart. Especially anything to do with earnings or dividends, because a cut to either could signal slowing corporate profits. For a very expensive market, that’s not good.
Bulls will take heart in knowing that the dividend cut, to a large extent, appears to be company-centric.
It was only last month that GE’s board elected John Flannery to succeed Jeffrey Immelt as CEO of the company. Other high-profile turnovers followed, including the retirement announcements of vice chairs Beth Comstock and John Rice. The CFO is changing guard too, with Jamie Miller (former CEO of GE Transportation) succeeding Jefferey Bornnestein in October. (Source: “General Electric announces slew of executive changes, including new CFO,” CNBC, October 6, 2017.)
That’s an unusual amount of leadership turnover in such a short period of time. No doubt, they saw a muddled profit situation coming and decided to step aside. After all, General Electric, with its 300,000-strong employee base and complicated business structures formed over the past 125 years, is not an easy turnaround.
Undaunted, CEO John Flannery announced just that when he unveiled a roadmap that focused on three of GE’s biggest business lines—aviation, power, and health care—while still committing to the dividend long term. “We understand the importance of this decision…We are focused on driving total shareholder return and believe this is the right decision to align our dividend payout to cash flow generation.” (Source: “For The First Time Since The Financial Crisis GE Slashes Dividend In Half,” Zero Hedge, November 13, 2017.)
The dividend cut was actually predicted by the options market. GE’s 12-month dividend yield had been trading at recent highs against GE’s 2032 bond yields. This wasn’t a sustainable situation. Goldman Sachs Group Inc (NYSE:GS) analyst Joe Ritchie picked up on this fact, warning back in October that a major earnings/free cash flow reset was coming. He was ultimately proven right. (Source: “GE Options Are Pricing In Massive Dividend Cuts,” Zero Hedge, October 19, 2017.)
Considering the leadership changes and strategic refocus, it’s easy to shrug off GE’s dividend debacle as a one-off. But that doesn’t answer the question of why earnings and free cash flow are nosediving while the economy is cruising at business cycle highs.
Slowdown in GE’s Industrial Divisions
For the past several quarters, General Electric earnings have been lagging. After rebounding from a sharp downswing caused by charges in relation to the divestiture of GE Capital, earnings again have been drifting lower. It’s idd, considering the oild and gas sector has gradually improved and the economy is trending upwards.
The lower earnings plateau is directly related to a sizable drop in earnings. For the second quarter 2017, GE registered $29.6 billion in revenue versus $33.4 billion revenue in Q2 2016. That’s an 11.37% drop over the past year. Call it GE’s version of a personal financial crisis.
Given GE’s nebulous business and accounting structure, we’re no experts on the precise causes of its year-over-year revenue declines. But it’s not hard to question the strength of the economy, given GE’s inability to excel in “good” economic conditions. In other words, GE should be hitting it out of the park right now, not struggling to stay in the game. As a premier industrial bellwether, it’s hard to envision other industrial companies aren’t just as vulnerable.
While there’s emerging evidence backing this thesis up, a particular anecdote comes to mind. It highlights the stealth vulnerability the economy faces underneath the rosy headline growth numbers.
For example, UBS‘s chief economist Arend Kapteyn notes that 70% of global growth acceleration in 2017 was due to the commodity bounce. America contributed 20% to that total, mostly through energy investment. But if you strip out the commodity bounce, underlying U.S. GDP growth is only about one percent, the lowest since 2010. (Source: “UBS Makes A Striking Discovery: Ex-Energy, US GDP Growth Is The Slowest Since 2010,” Zero Hedge, November 13, 2017.)
Our Verdict
On a day where General Electric lost 7.22% of its value, the DJIA managed to eke out a small gain. So for now, it appears the market is treating GE’s dividend slash as a company-specific issue and not a harbinger of a financial crisis for industrial stocks. And the market may very well be spot-on.
But we can’t help but wonder whether General Electric’s inability to grow earnings is less a symptom of internal strategy, and more a result of a stealthily tough business environment. It’s not like it’s concentrated in a few sectors of the economy. GE’s reach is everywhere, and it’s as diversified as giant industrial conglomerates come.
Perhaps the real answer lies somewhere in the middle. But that shouldn’t comfort investors pinning their hopes on equities already priced for perfection.
