After Dismal 3rd Quarter Free Cash Flow, GE Retrenches
We think the firm's dividend is at risk, and are cutting our fair value estimate.
We plan to cut our fair value estimate by as much at 10% following General Electric’s (GE) third-quarter earnings report, which revealed deeper challenges in the power segment than we had anticipated. We now expect industrial free cash flow through 2018 to be lower than our prior projections, with modest growth returning in 2019 and beyond.
Underperformance in the power segment, driven by a lower volume of high-margin services and aeroderivative equipment, weighed heavily on industrial cash from operations, causing new CEO John Flannery to halve management’s original 2017 target of $12 billion-$14 billion in industrial cash from operations. With only $7 billion now expected for the year and approximately $3 billion-$4 billion of capital expenditures anticipated, industrial free cash flow will fall far short of GE’s $8 billion dividend commitment. More concerning is the suspension of GE Capital dividends, pending actuarial analysis of claims reserves in a long-term care insurance business. Absent these dividends to the parent, and with Flannery positioning 2018 as a trough or "reset" year, we think it would be irrational for GE to maintain its current dividend. Flannery did not explicitly confirm a cut but hinted that GE would be managed for total shareholder return going forward.
When Flannery shares his strategy Nov. 13, we expect he will outline steps to rightsize the power business and drive excess costs out of the entire portfolio. We also anticipate further details on the $20 billion of potential asset sales earmarked Oct. 20 and how that will tie into GE’s new capital-allocation philosophy. From a long-term perspective, we think all is not lost. When excluding the power and oil and gas segments, the rest of GE’s wide-moat portfolio reported 2% organic revenue growth, 250 basis points of margin expansion, and strong growth in high-margin service orders in the quarter. This is a solid foundation that can produce attractive future returns under better management.
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Barbara Noverini does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.