Industrials
10 Harsh Realities GE Shareholders Will Have to Face From 2018 to 2020
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Sometimes everything in the markets looks good on the surface. The Dow blew through 23,000 like a knife through butter, and the very preliminary views from this week are pointing to Dow 25,000 in 2018. And so far the economic numbers are recovering after two major hurricanes at the same time that earnings season is looking strong. Tax reform even has a better shot of coming after three decades.
Unfortunately, all this good news is not being felt universally. Investors who are overweight in General Electric Co. (NYSE: GE) are not getting to enjoy all of these great things happening in the U.S. economy and the rekindled global growth story.
24/7 Wall St. has covered General Electric’s earnings for years, and this week’s third-quarter earnings report that sank the stock was the worst post-recession report we have seen from any of the major conglomerates in years.
Now it’s time for shareholders to accept some realities that are likely to occur from 2018 through 2020. Some of these are issues outside of the company’s control, while other things addressed here likely have to happen for General Electric to prosper ahead.
Be advised that some of these things may be denied by GE’s new management. That doesn’t mean that they won’t occur, and it definitely does not mean that they should be ignored.
Also note that CEO John Flannery’s ultimate long-term views on the future of General Electric are not going to be showcased until November. That means long-term earnings per share guidance, its focus areas, its areas to be dumped or reduced. And everyone knows that goals and targets issues in one year may change handily throughout the business cycles ahead.
Here are 10 long-term issues that GE shareholders will have to consider for more than just the next few months or year.
1. Jeff Immelt and Prior Management Smearing
Whether this will come from the company itself or it will be made by analysts and the media remains to be seen. Jeff Immelt never had the halo around himself that Jack Welch did when he retired. Immelt took control of GE literally days before the 9/11 terror attacks in 2001, and that hamstrung his efforts to keep the company growing into what was already a very weak business climate and mild recession at the time.
Either way, Immelt and his prior team made many mistakes in buying assets high and dumping assets at what was proven to be low prices after the fact. If Immelt’s company jet habits have been leaked out, it seems fair to assume that Immelt’s tenure and the operations of Immelt’s top guard will have to keep taking some blame ahead.
2. Analysts Have to Adjust Their Price Targets Lower and Lower
When you get a situation of the sort that has been seen at GE in 2017, all those analysts with $33 and $35 targets that were late to lower them end up with the proverbial egg on their face. That means that GE’s analysts are likely not yet finished trimming their price targets. The consensus analyst target at the start of 2017 was $33.86 (versus a $31.60 share price at the time), and now that was down closer to $28 even before the earnings disappointment took GE to yet new 52-week lows.
Some analysts are going to say that there are many similarities between GE and IBM, and that means that a long-term growth strategy remains elusive. Other analysts may keep their Buy or Outperform ratings but will have to become more realistic on their price targets. If Buy and Outperform analyst ratings have implied total return expectations of 8% to 15% on most Dow and S&P 500 stocks, they can’t easily keep projecting 25% and 35% upside in GE.
24/7 Wall St.3. Cost Cuts and Restructuring Charges Will Mount
It has been reported that GE has reviewed layoffs for any non-revenue segments within its units. GE’s layoffs are probably only going to grow, with thousands of employees already targeted. The company has close to 300,000 units, and Flannery has indicated that there are no sacred cows and that the company is too geographically spread out.
Flannery also has said that the first year of restructuring will be tough, and it may take years to get it right, but this means ongoing layoffs either in groups or on an individual basis after internal-unit and external-unit reviews. That also comes with ongoing restructuring charges ahead. GE operates in more than 180 countries, and that can become an expensive footprint with many laws and regulations to have to keep up with.
4. Adding Businesses and Cutting Businesses Will Continue
Immelt by and large pursued bolt-on acquisitions in his tenure, but GE underwent massive change. GE is now far less of a consumer credit card company and bank. Its finance arm has been chopped down massively, and it has sold its appliances, NBC/Universal, other media and other units. And GE has grown in health care and in energy.
Flannery has said that there are no sacred cows, and the current figure used is that $20 billion worth of GE operations businesses could be sold or spun off. Flannery is without emotion when it comes to the existing GE industrial portfolio. The case is easy to make that GE eventually could unload its majority stake of Baker Hughes, A GE Company (NYSE: BHGE) after just having completed that acquisition.
There are literally endless lines of products that GE could sell off that are not deemed to be core. With such a large international footprint and with layoffs and restructuring already touted, there are going to be some continued unit or product sales. The question now is whether Flannery uses the restructured company ahead as an acquisition vehicle to further solidify its areas of strength.
5. The Case for a GE Breakup Will Be Made Much Louder
There has been talk for two decades about GE’s conglomerate structure being too hard to manage and that the company should be broken up. Trying to understand GE’s balance sheet has always been more than difficult. And the cross-selling among the units and GE Capital have always been strong. The calls for a breakup of GE will be made by the media and by outsiders, perhaps by even more vocal activist investors.
There is a serious problem in breaking up GE. The cash flow pictures are harder to communicate and the organizational structure has shared overlap to the point that it might be more expensive for some of these big units to operate independently than if they were not their own businesses. You are going to hear a lot about this thought in the months ahead, so just get used to it. Flannery told CNBC in an interview that you do not have to separate units to have them run better, but if there are no sacred cows then anything (including a break-up) may be possible in the years ahead.
6. Out With the Old Guard, Redux …
The saying “The king is dead. Long live the king!” will not apply at GE for some time. Flannery has systematically forced out some of the unit-heads who presided under Immelt. Others have left on their own, which is typical after many candidates are disappointed that they were not chosen as the heir to the CEO throne. The board of directors is going to keep changing as well. There is even a new chief financial officer, which can spook even the investors who have the highest conviction that GE’s best days are ahead.
Just don’t think for a second that the remaining people from the old guard are going to be kept around indefinitely. There may be a few people who are not purged, but some very key people of the past decade may be planning an early retirement from GE in the coming months or years. Some of those exits and retirements likely will be far from voluntary.
7. Accounting and Balance Sheet Questions
When GE replaced its CFO and other top lieutenants, there was some concern about what this might mean regarding GE’s books, either in the past or ahead. There have been accounting settlements in the past and reports of implementing an accounting standard update, but we will not go so far as to use the formal terms “mistakes” and “irregularities.” Both are very bad for investors, and the end result remains unknown.
Anytime there are sweeping changes, drastically lowered earnings and the new head honcho calling results unacceptable, there may be worries by investors about what disclosures may be coming. Problems around long-term care and turbines are there, but the reality is that GE already has shed so many assets and is committing to shedding more of its less profitable divisions or operations that it’s hard to imagine what risks are ahead in the books of a company this spread out in businesses and geographies.
Understanding GE’s balance sheet also requires advanced accounting knowledge, and sometimes the feeling that it requires understanding alchemy. Bloomberg said ahead of the third-quarter earnings that GE issues four earnings per share numbers and that the adjusted profit obscures actual performance. Whether Flannery cleans house swiftly and rapidly or takes his time, GE could continue to be a very hard company to analyze by the books.
8. Dividend Cut and Capital Allocations
Two analysts speculated ahead of earnings that GE would have to cut its dividend. Immelt vehemently denied this, but Flannery was far less committed to the actual rate of the dividend versus having a dividend. In a CNBC interview he even went as far to say he was not emotional about a dividend. His view is that if you should pay a dividend then pay it, if it was to buy back stock then buy the stock, and if it was for an acquisition then that is what to do. GE’s all-in cash flow and the GE Capital dividend paid to the parent is lower.
24/7 Wall St. predicted that GE needed to cut its dividend going into the Great Recession to save literally tens of thousands of jobs. At this time, a dividend yield above 4% is just too high, and Flannery can say Immelt raised its payout too much without taking the blame. Get ready for a GE dividend cut, or get ready for the company to face more financial leverage concerns if it doesn’t. GE’s dividend liability for the common stock is more than $8 billion.
24/7 Wall St.9. Ratings Agencies to Endlessly Review GE
The credit ratings have gone through their case of downs after missing so much in mortgage and credit risk ahead of the Great Recession. Still, they are not bashed every day anymore and it turns out that domestic and global bond investors have to still rely on some outside credit analysis on what bonds they can or cannot hold.
GE is going to face multiple credit ratings reviews for years from the likes of S&P, Moody’s and Fitch. If the company lowers the dividend, it may be credit-positive for debt holders, depending on the logic. If GE’s earnings power remains soft for years, or if the parent is dragged down by too many units, then the credit ratings will keep voicing concern. GE used to be a solid Triple-A credit rating, but those days are long gone. Unfortunately, GE’s debt holders and equity holders may have to read credit rating reports for years into the future.
10. Understanding That Huge Ships Take Years to Turn
GE’s loyalists and investors need to understand that this is not just a ship that needs to be turned around. It is a whole armada. Think about restructuring and layoffs. Think about asset sales and acquisitions. Think about how long it takes to get the right team (or teams) in place, as well as cutting mistakes along the way. Think about changing dividend and capital allocation. And think about all the outside pressure that will be headed Flannery’s way.
Investors have a hard time expecting that a large ship takes a long time to turn around. Now imagine turning around a whole armada full of different units that have to all be transformed into the new GE culture. GE’s stock may make different voting reactions up and down as a scorecard for how the GE turnaround looks ahead, but it seems reasonable to expect that it could be late in 2018 or well into 2019 before long-term investors have a full handle on what the new GE is going to be.
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