Just a few days ago, J.P. Morgan analyst Stephen Tusa suggested industrial giant General Electric Company (NYSE:GE) should be — if it wasn’t — mulling the possibility of yet another dividend cut. Though the payout is important to a wide swath of GE stock owners, it arguably isn’t the best use of income for a cash-strapped, debt-laden company, he says.
He’s got a relatively good point. Of all the ways the company could allocate its operating cash flow in its present situation, sustaining the dividend payout seems to make the least mathematical sense. Paying down its debilitating debt and investing in much-needed growth superficially seems like a more important priority.
It’s a call that oversimplifies GE’s situation though, and glosses over a stark reality.
What He Said
Tusa’s explanation was straight-forward enough: “With little available cash flow to naturally de-lever, we don’t see how, from a risk mitigation perspective, a company of this size and complexity cannot be seriously considering at least a dividend cut and/or a more aggressive approach to reinforcing its capital base.”
That reinforcement would come in the form of whittling down roughly $106 billion in debt and/or securing some capital to invest in ventures that create additional cash flow.
For perspective, GE has been making interest payments of about $700 million per quarter — and will likely keep doing so in the future, at its present debt load — leaving behind roughly $2 billion per quarter in normalized, post-tax net income. The current dividend of 12 cents per share of GE stocks costs the company about $1 billion per quarter.
It’s back-of-the-envelope math, but still makes clear that Tusa’s thinking makes sense. It also reinforces similar doubts about the company’s dividend expressed by Cowen and RBC Capital Markets.
What if, however, we were looking at the matter through the wrong lens?
Cost Cuts Won’t Matter Much
Yes, General Electric is a fiscal mess right now. Even without explicitly saying so, relatively new CEO John Flannery tacitly said as much at an investor conference held last month by virtue of not guaranteeing GE wouldn’t cut its dividend again in the future, after halving it last year. At the same conference Flannery also made clear that the company’s once-iconic power division was still struggling, and would be for a while.
To that end, the premise of selling off pieces of itself to supply cash and pay down debt makes sense as a chance at immediate relief. Case in point: General Electric announced last month it was selling its locomotive business to Westinghouse Air Brake Technologies Corp (NYSE:WAB), better known as WabTec.
Even that deal was soon criticized, though, as being too small and too late to do enough meaningful good. GE will only net about $2.9 billion in immediate cash from the deal, and up to a total of $5.4 billion when all is said and done … not enough to “move the needle too much,” as RBC analyst Deane Dray put it.
Moody’s also pointed out that by shedding the GE Transportation unit, General Electric will in turn be shedding an asset that drives an estimated $450 million worth of annual free cash flow. Moody’s senior credit officer Rene Lipsch further opined that the relatively fruitless WabTec suggests that GE’s rush to divest could do more damage than good to the bottom line.
All of a sudden another dividend cut makes even more sense.
Go back and crunch the numbers though, and think about them critically. Even if General Electric were to cut out its dividend altogether, that extra $4 billion wouldn’t even make a noticeable dent in the company’s mountain of liabilities.
Tusa believes GE needs a total of $32 billion in fresh capital to move to the positive side of the debt teeter-totter. Halving the dividend again still leaves it well short of that number, putting investors’ focus right back where the company’s been focused since Flannery took over … on making the former breadwinner power division the profitable beast it once was.
Simply put, the company probably won’t be able to divest its way out of trouble, and it certainly can’t cost-cut its way out of trouble. GE can only grow its way out of trouble.
The good news is, Flannery is moving in that direction. It takes time though — time not all investors are prepared to give it.
Bottom Line for GE Stock
It’s admittedly easy to oversimplify a complex situation in an effort to merely simplify it. So, to be clear, the “truth” about the merits of cutting GE’s dividend and the pointlessness of doing so is somewhere in the middle of the two extremes. There is no “better” outcome; both options are “bad.” The trick for Flannery is simply figuring out which decision is “less bad,” recognizing that at the very least, GE stock is psychological currency.
That is to say, further reductions of the dividend will further mar the company’s reputation, making it even tougher to do business with General Electric going forward. It’s not fair, nor is it completely logical. The market, and marketplace, isn’t always fair or logical though.
Whatever the case, Flannery likely realizes that spending a modest $4 billion per year on dividends maintains some much-needed goodwill, and is indirectly worth far more than $4 billion to the company.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
