Here comes General Electric’s turnaround plan. It better be good
For much of the past century, General Electric Co. — whose history stretches back to Thomas Edison’s lightbulb — had been a symbol of the by-the-numbers management credo that ruled American business before the digital age. But GE’s eyesore of an earnings report on Oct. 20 leaves little doubt that the 125-year-old company, with a market value of $186 billion, is facing a financial and cultural senior moment.
This icon of American industry has been forced to cut its earnings and cash flow outlook so drastically that investors are now preparing for a onceunthinkable cut to its dividend. A rapid-fire series of high-level departures over the past few months, beginning with longtime Chief Executive Officer Jeff Immelt, represents a jarring transition for the company. There’s even speculation that GE, the only member of the original Dow Jones industrial average still on the benchmark, could get dropped from the list.
“There was a long stretch where GE was viewed as a management leader,” says Scott Lawson, a vice president at Westwood Holdings Group Inc., which oversees more than $20 billion in assets. “Sometimes the memories last much longer than the reality.”
GE’s shares have fallen 32 percent in 2017, their worst year-to-date performance since the financial crisis. But there’s no market crash to blame this time. Instead, some analysts say much of the cause lies with management’s poor capitalallocation decisions and GE’s cultural shortcomings — and those are actually harder problems to fix.
GE cut its 2017 earnings guidance to $1.05 to $1.10 a share—far below an initial forecast of $1.60 to $1.70. Likewise, its target for cash flow from industrial operating activities was cut almost in half, to $7 billion. New CEO John Flannery’s frankness about GE’s failures is a refreshing change to many investors. But it’s a sign of how much work needs to be done that things had to get this dire for management to have an honest discussion about cash flow and earnings challenges that analysts have highlighted since at least 2016.
Flannery is set to reveal his turnaround plan for GE when he meets with investors on Nov. 13. Many of the specifics thus far are of the symbolic variety: grounding private planes, pledging to get rid of confusing earnings adjustments, and putting a representative from activist investor Trian Fund Management LP on the board. Those tweaks and even the $20 billion in divestitures Flannery says he’s considering will do little to stanch the bad operating results that will persist at least through next year.
One change that could make a difference — though a challenge to GE’s very DNA — is a reduction in its dividend. The company was forced to cut the payout during the Great Depression and again during the financial crisis. The latter instance was dubbed by Immelt as “the worst day of my tenure as CEO.” Now Flannery may have little choice but to do so again.
After capital expenditure and pension commitments, GE will have only about $2 billion of free cash flow from its industrial businesses this year. The dividend costs more than $8 billion. It doesn’t take a mathematician to see that’s a problem. GE does have cash on its balance sheet that it can use to plug this year’s gap. But Vertical Research Partners analyst Jeff Sprague estimates free cash flow from its industrial businesses will again fall short of what’s needed to cover the dividend in 2018, given the struggles in GE’s power unit.
GE has already lavished almost $50 billion on investors via share buybacks in the past few years. And directing proceeds from additional borrowing to the dividend rather than investments that might actually help its businesses generate stronger cash flow would be unwise. Without a dividend cut, Flannery’s plan to divest $20 billion of assets would likely be just another stopgap that would actually exacerbate the cash crunch by reducing free cash flow.
That would be a continuation of a pattern that helped create GE’s predicament. Under Immelt’s watch, the company unwound GE Capital, put its appliances, water, and industrial-solutions units up for sale, and divested its stake in NBCUniversal. While there’s nothing wrong with simplification, JPMorgan Chase & Co. analyst Steve Tusa has estimated those divestitures reduced free cash flow by about $7.2 billion. Acquisitions such as the $10.6 billion purchase of Alstom SA’s power assets in 2015 don’t generate enough cash to make up for that. So GE’s resources have gotten smaller, but its dividend hasn’t.
Beyond dismantling the private-plane excesses of Immelt’s tenure, Flannery may need to consider tackling his own legacy, too. He’s a 30-year GE veteran whose contributions include the Alstom acquisition—a purchase that increased GE’s exposure to power markets now being roiled by sluggish demand and pricing pressure. About $3 billion of the drop in GE’s 2017 expected cash flow is attributable to the power unit.
JPMorgan’s Tusa has argued that the challenges facing the power division aren’t a blip but rather the start of a slide to a new normal of lower profitability. If that’s the case, perhaps the dividend isn’t the only legacy Flannery may have to change.