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How Risky Is General Electric?

By Reuben Gregg Brewer - Oct 31, 2017 at 8:04AM

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General Electric's shares have been hit hard, but that could be a buying opportunity for long-term investors.

Third-quarter earnings at General Electric Company (GE -0.20%) were basically a disaster -- with CEO John Flannery calling the company's performance "unacceptable." It's no wonder the shares plunged after the report. But is it time for investors to run for the hills or an opportunity to invest in this industrial giant? There are definitely risks today, but if you have the stomach for turnarounds, they may be worth taking on.   

That nice yield may not last

General Electric sports more than a 4% dividend yield today. That's very enticing when an S&P 500 Index fund will get you only around 2%. Before the third-quarter earnings report, I believed that the dividend was on solid ground, but now I'm not so sure. If the only reason you're interested in GE is the yield, you should probably be looking somewhere else at this point. Put simply, the risk of a cut is large.

Two men in blue hard hats review documents on a factory floor

Image source: Getty Images.

My concern stems from the fact that Flannery highlighted during the third-quarter conference call his awareness of how important the dividend is to shareholders. However, he went on to explain that the company needed to balance its growth plans against the dividend.   

My guess is that the dividend gets trimmed now so that the CEO, who only took the helm a few months ago, can get all of the bad news out of the way. It's the kitchen-sink approach, which will help to make the rest of his tenure look better.

Not the end of the world

That said, it looks as if General Electric's problems are really near-term in nature today. But it's understandable if investors are a little skittish. During the 2007-to-2009 recession, GE's entire future was put in peril by its oversized financial arm. The troubles at that business even led to a government bailout for the company.   

But the CEO at the time, Jeffery Immelt, went to work streamlining the industrial giant back to its core. He sold off assets that didn't fit, like a television network, and jettisoned financial businesses that didn't directly support GE's industrial business, like insurance operations. Immelt left his successor with a much more focused company.

A summary of GE's third quarter results, showing the weakness in several key businesses

The big-picture view of the GE's tough third quarter. Image source: General Electric Company. 

The work, however, isn't done yet. And Flannery plans to use his first days as the head of GE to cut costs, selling off the corporate jets and killing a free-car program for managers, and to continue the streamlining process, including completing the sale of the water business and getting out of consumer lighting. But this is a vastly different job from what Immelt was left to deal with when Jack Welch handed him a company that had, in hindsight, veered off course by venturing too far into the finance business.   

But it's still kind of ugly

I'm not wearing rose-colored glasses. GE's third-quarter results stank, missing analyst earnings expectations by a massive 40%. There was plenty of bad news, with operating profit in the energy business down 50%, oil and gas off by 35%, and transportation operating profits falling 11%. Although some of its business did OK, the negatives pushed industrial segment profits down by 10%. Another problem was shrinking margins, hence the cost-cutting effort.   

General Electric is clearly not hitting on all cylinders today. But it still has an iconic brand name, dominant positions in the industries it serves, and a reputation for quality. Moreover, some of the key markets it serves are weak today, notably oil and gas, but that won't last forever. When typically cyclical industries like that pick up again, some big headwinds will become tailwinds.

GE Chart

GE data by YCharts

The company's finances, meanwhile, are pretty solid, though at first blush you might be tempted to think otherwise. Long-term debt makes up around two-thirds of the company's capital structure. But if you add in the massive $78 billion in cash and marketable securities on the balance sheet, that number drops to around 30%. Despite the falling stock price, there's little reason to believe GE is going to go out of business today. It just needs to get its business heading in the right direction.   

If you can stomach it

GE's shares have vastly underperformed its industrial peers for a very good reason: Things aren't going well today. And with a new CEO, it's likely the next year or so will continue to be tough as he moves quickly to get as much bad news behind him as possible. That increasingly looks as if it will mean a dividend cut.

But this isn't a life-or-death situation. It's more like resetting investor expectations. And once this "tough love" period is over, GE will likely start to look a lot more interesting. But at this point, you'll need a thick skin to stick around because the headlines are likely to be negative for at least another 12 months or so. Just remember that the risks today aren't the same as the ones GE was dealing with back during the financial meltdown.

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