It’s been a tough year for General Electric Company (NYSE:GE), with GE stock down about 23%. It’s got investors wondering if the worst is already over. However, with a new CEO still getting acclimated and cash flows eroding, that may not be the case.
When we last took a look at GE stock, cash flow was a big concern. After several fat years, General Electric has seen this metric severely decline. In each the three years prior to 2016, GE generated operating cash flow (OCF) north of $19 billion. In fiscal 2016, though, OCF fell to negative $244 million. This is concerning, although both quarters so far in 2017 have been OCF positive and perhaps that will relieve investors’ stress to some degree.
Also, GE generally generates billions in free cash flow (FCF). So despite its somewhat lackluster execution over the past few years, investors have been willing to overlook its flaws. Part of this was due to its dividend, a yield of which has now swollen to about 4%. However, the billions in FCF hasn’t been the case lately. In fact, in both quarters of 2017, General Electric has had negative FCF. That’s what’s got investors now worrying about the dividend and wondering if the new management may resort to cutting or reducing its payout.
The New Regime
Wrapping up the last conference call of his tenure, former CEO Jeff Immelt said the dividend was safe, calling it a priority going forward.
Still, Immelt isn’t the CEO anymore. While it wasn’t a total C-suite refresh, new CEO John Flannery may have the same priorities. His management team may also use this opportunity to “kitchen sink” the next quarter. That is, lower all expectations — as if they aren’t low enough — in order to reset the bar and make for some easy hurdling down the road.
I’m not saying that Flannery, et.al. will cut the dividend, but it’s a risk to be aware of. I’m also not saying they will for sure kitchen sink next quarter. If they did, though, and GE stock didn’t fall, that would be a big-time buying opportunity. These are near-term risks, but I also think they’re risks that investors have started to take into account given GE’s poor performance.
Valuing GE
Given all of the recent issues and headaches, it’s worth asking how much GE stock is really worth. Surprisingly, GE may be a worthwhile endeavor for patient investors. Analysts expect General Electric to earn $1.57 per share this year, representing earnings growth of 5.4%. In 2018, they expect that figure to grow another 8.3%. On the sales front, forecasts call for growth of 1.7% and 4.8% in 2017 and 2018, respectively.On a forward price-to-earnings basis, GE stock trades at just 14.3 times. That’s actually not a bad price for a stock with 5% to 8% earnings growth over the next two years and a 4% dividend yield. I find that attractive.
However, the question really centers around whether GE can achieve that earnings growth and maintain its payout. A recent report suggests that GE is looking to cut costs around its software platform, Predix, which connects equipment like turbines and elevators to computers to predict failures and reduce operating costs.
GE has poured resources into Predix’s success. But GE recently had to reduce its revenue outlook for its GE Digital business, where the software operation sits. Instead of $15 billion in revenue in 2020, the company expects $12 billion in sales.
To be sure, this is still a few years off and represents less than 10% of total current revenues. While investors will want GE Digital to excel in the future, meeting profit forecasts for 2018 would be welcoming for investors.
Reports about GE Digital, along with reports on reducing costs and boosting profits, show that Flannery may indeed be tackling GE’s current issues head on. If he’s able to grow earnings 8.3% in 2018, GE stock seems undervalued.
Trading GE Stock
When we previously talked about GE stock, there was a defined risk-reward scenario. The ~$25 level was solid support. Now that that level has given way, there’s nothing significant between current prices and the next strong level of support at $22.At $22, GE stock would yield close to 4.4%. I’m not sure that GE stock will get there, but if it were to fall that far, it would again be attractive. The company isn’t doing great, but it’s not going bust. Presuming GE continues paying its dividend, this would be a great risk-reward level.
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Here’s the bottom line: Given the current company-specific issues and potential geopolitical pressure on the broader market, GE stock on a pullback is preferred. As it stands, disappointing growth and/or a dividend reduction is on the table, although perhaps not necessarily likely. Given these risks, waiting seems prudent.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
