Even the best blue-chip stocks have drawbacks. Yes, even General Electric (NYSE:GE), a company that has served as the bedrock of the American economy and stock market for over a century. While it has remade itself multiple times in its illustrious history, that's not to say that each transition has been completed swiftly and smoothly.
Mr. Market hasn't been quite sure what to make of the stock since management decided to shed the bulk of its financial services unit and instead focus solely on industrial services and manufacturing. General Electric trails the returns of S&P 500 in the latest one- and three-year periods -- with or without dividends included. Despite that performance, and headwinds in key industries, investors shouldn't be deterred. Here are three terrible reasons to sell the stock.
Lackluster stock performance
Over the past year, General Electric has returned 1% with dividends included, which is far behind the total returns of the S&P 500. That's dreadful, but especially so when you poke around the details. The stock is underperforming the index despite (1) offering a higher dividend than the S&P 500 and (2) spending $22 billion on share buybacks in 2016. The latter reduced the number of shares outstanding by 7% -- no small feat for a $260 billion company.
Increased dividends and share buybacks in 2015 and 2016 have been management's olive branch to investors patiently waiting out the gradual exit from financial services. But as the unit becomes smaller, it will contribute less to the company's overall cash flow (from GE Capital dividends paid to General Electric) and will result in fewer asset sales over time. For instance, total cash returned to investors this year will amount to between $19 billion and $21 billion, compared to $30.5 billion last year.
While the key cogs in the industrial unit's machine will continue to improve, it will not occur quickly enough to offset the ratcheting down of cash flows from financial services. That hints that the stock could continue to move sideways in the near term, but that doesn't mean investors should give up on General Electric stock.
The long-term potential of the company remains intact, thanks in no small part to several huge bets on next-generation industrial services and manufacturing. Consider that GE Digital software revenue is expected to grow 20% to 30% in the year ahead to at least $5 billion, while revenue from Predix, the company's Industrial Internet offering, could top $1 billion. It may seem like small potatoes today, but it could translate into a dominant business for General Electric in the long term. And that's exactly the point: Investors sticking around today are betting on the industrial unit's future, not short-term changes in the stock price.
Nuclear business fallout
The nuclear industry just can't seem to catch a break. Toshiba, which has been embroiled in an accounting scandal and is suffering from devastating financial losses, announced that it will exit the nuclear construction business after it's Westinghouse unit lost $6.3 billion in 2016. Toshiba acquired the nuclear leader for just $5.4 billion in 2006 -- beating out competing bids from General Electric.
Some say it could signal the end of new nuclear power plants in America, since Westinghouse is one of the only companies on the planet -- and the only one in the United States -- with long-term experience building them. That loss of institutional knowledge wouldn't bode well for General Electric. The GE Hitachi joint venture is one of the leading companies in the industry performing various services for nuclear power plants. While it divested its Canadian business in 2016, the company is betting heavily on the future of nuclear power with its industry-leading design for a Generation IV reactor, called PRISM.
But there are reasons for optimism.
PRISM is a small modular reactor. Many of its components are expected to be assembled in a factory and shipped to site for installation, which would mark a major advantage over traditional nuclear reactors (all reactors in service worldwide today). While Westinghouse also promised a streamlined construction process for the severely delayed reactors, PRISM is almost half the size of the AP1000 design from Toshiba's unit. It's also meltdown resistant and can run on nuclear wastes, which should be key selling points to government officials and regulators tempted to enact policies that nurture atomic energy.
To be fair, GE Hitachi will face some of the same regulatory and institutional obstacles, but I don't think the joint venture's nuclear ambitions should be dismissed because of traditional nuclear power's struggles. After all, those are the same struggles the PRISM is designed to overcome.
Coal power's "resurgence"
One of the crown jewels of General Electric's energy unit is the Harriet gas turbine, which is among the largest and most efficient available. In fact, with an efficiency rating of 62.22%, it's the most efficient gas turbine available. Despite the leadership position, investors may be worrying what could happen from a resurgence in coal power generation at the expense of natural gas' growth, as predicted by the U.S. Energy Information Administration.
It may seem unlikely, but the EIA expects that American coal production will grow in the next two years. And if enough emissions regulations are eased and energy prices fluctuate just right, the rate of coal power plant closures could slow significantly, which would limit the need for new generation capacity overall. That could be a blow to the rise of natural gas, but it's unlikely to have much of an effect on General Electric.
That's because the Harriet is a combined-cycle turbine -- a technology that comprises the vast majority of new natural gas installations. Power generators can save millions of dollars in fuel costs with combined-cycle turbines, which will help the technology weather any headwinds from near-term shifts in the energy market. Traditional combustion turbines may bear the brunt of increased competition from coal. That should help General Electric continue to ramp sales of the new turbine.
What does it mean for investors?
Investors are certainly being asked to take a leap of faith with General Electric's new direction. For instance, the massive multiyear share buyback will help to boost EPS, while masking a decrease in total net income from previous years. And although the performance of the industrial unit continues to gather strength, it's unlikely to make up for the loss of the financial unit in the short term. But if management is proven correct over time for its insistence that the Industrial Internet represents an enormous global opportunity, then long-term investors should be handsomely rewarded.