While dividend collectors might not consider the company’s ongoing dividend frugality to be a good thing, I believe General Electric ought to make its one-cent dividend a permanent move. Here’s why.
Save Money for Other Capital Allocation Uses
There are five uses of free cash flow: Reducing debt, internal growth projects, share repurchases, dividends and acquisitions. For CEOs where free cash flow is piling up — Apple (NASDAQ:AAPL) has almost $59 billion over the trailing 12 months — it becomes a challenging, but enviable, task of allocating capital most productively.
However, when it comes to General Electric, CEO Larry Culp said in March that it would have negative industrial free cash flow in 2019. Since then, the picture’s brightened considerably with the company stating in late October that the figure would likely end the year in positive territory.
“We are encouraged by our strong backlog, organic growth, margin expansion, and positive cash trajectory amidst global macro uncertainty. We are raising our Industrial free cash flow outlook again even with external headwinds from the 737 MAX and tariffs…” Culp stated in its Q3 2019 press release.
At the end of September, General Electric had a nine-month industrial free cash flow of -$1.6 billion. This is an increase from -$303 million a year earlier. Yet, Culp believes the company will deliver as much as $2 billion in industrial free cash flow in 2019 and further growth in fiscal 2020 and 2021.
Let’s assume for a second that General Electric does generate $2 billion in industrial free cash flow in 2019. There are much better uses for that $2 billion than paying a 12-cent dividend — a payout that Culp cut to one-cent very shortly after taking over as CEO.
An annual payout of 48 cents requires $4.2 billion in cash based on 8.7 billion shares. That’s $2.2 billion more than its best-case scenario for industrial free cash flow. To pay out a penny per quarter reduces the cash requirement to $350 million. This leaves over a billion and a half for other capital allocation uses.
A Lot of Debt
General Electric’s industrial net debt at the end of September was $49 billion, down from $55.3 billion at the end of December. These figures include both short- and long-term borrowings along with its pension and retiree benefit plan liabilities less cash.
Certainly, Culp wants to continue to reduce this number; And so he should. If a recession hits in 2020 or 2021, shareholders will be happy the debt load is a tad lighter.
Although $1.65 billion in debt repayment is only a 3.4% reduction in its net industrial debt, it’s better than nothing. If Culp sticks to his outlook, there will be a much bigger indent in 2020 and 2021.
To return the dividend to 12 cents per share would only attract the wrong kind of investor.
General Electric doesn’t need coupon cutters in its midst. It requires investors willing to follow Larry Culp’s turnaround, and those ready to trade a little income for growth.
As General Electric rebuilds its industrial free cash flow, every capital allocation lever except for a 12-cent dividend should be an option. That includes share repurchases, because General Electric once traded as high as $58 (September 2000), more than five times its current share price.
The Bottom Line on General Electric
In 2000, General Electric’s industrial free cash flow was $12.9 billion.
At the time, dividends accounted for 44% (57 cents paid out during fiscal 2000) of its free cash flow generated. That said, there was plenty of room left for internal growth and acquisitions.
A smarter way to reward shareholders is to make the one-cent quarterly dividend permanent, while using special dividends and share repurchases as free cash flow exceeds internal needs for growing its business.
General Electric is a long way from being able to afford this luxury. However, I believe it’s time for the company to focus on renewing their growth.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.