It's been less than a year since General Electric (GE 8.28%) slashed its dividend by 50% due to a downturn in its power segment and mounting problems in its GE Capital unit. However, some investors are bracing for another GE dividend cut after the company replaced its CEO, took a massive writedown, and abandoned its 2018 free-cash-flow guidance earlier this week.
GE's dividend was already higher than ideal relative to its free cash flow. As a result, the board could choose to reduce the dividend immediately to preserve cash.
That said, GE should have more than enough cash available to maintain its dividend for now. It would make more sense to reduce the GE dividend to a new baseline level after completing the planned spinoff of GE's healthcare business next year.
Free cash flow falls short
GE executives were already expecting weak results in the company's power business for 2018 when they announced the dividend cut last November. However, the downturn has been even worse than expected, driven by a combination of market factors and execution missteps.
In July, General Electric acknowledged that free cash flow would likely come in at the bottom of the company's $6 billion to $7 billion guidance range this year. Yet even that estimate was too optimistic. In the company's recent CEO transition announcement, GE stated that it expects to miss its free-cash-flow guidance.
GE will miss its free-cash-flow guidance due to weak results in its power unit. Image source: General Electric.
Not surprisingly, the three big credit rating agencies have already started to cut GE's credit rating due to its high debt load and plummeting cash flow.
Investors will have to wait for GE's third-quarter earnings report later this month for a new 2018 free-cash-flow estimate. However, given that GE's dividend coverage was already fairly weak -- the current quarterly dividend of $0.12 per share costs more than $4.3 billion annually -- a significant guidance miss on free cash flow will increase the pressure on the board to cut GE's dividend yet again.
GE has plenty of sources of cash
Despite this seemingly gloomy picture, General Electric doesn't really need to cut its dividend right away. Pessimists would note that GE ended the second quarter with only $8.9 billion of cash -- excluding cash held by separately traded Baker Hughes, a GE Company -- not much for a company of its size.
However, adjusted industrial free cash flow was -$1.6 billion in the first half of 2018, due to the seasonality of GE's business. In other words, GE will generate more than 100% of its annual free cash flow in the second half of the year. Even if adjusted free cash flow comes in at just $4.4 billion for the full year (more than 25% below the previous forecast), that would still imply adjusted industrial free cash flow of $6 billion in the second half of the year.
Acquisitions and dispositions activity will free up more cash over the next few quarters. GE sold its healthcare IT business for $1.05 billion last quarter and expects to close the $3.25 billion sale of its distributed power business in the fourth quarter. Even after paying about $3 billion to buy out Alstom's share of several joint ventures later this year, GE will net more than $1 billion of incremental asset sale proceeds by year-end.
Furthermore, GE should be able to close the sale/spinoff of its transportation division in early 2019. This will bring in immediate cash proceeds of $2.9 billion, plus about $1.9 billion of Wabtec stock that can be sold to further strengthen the balance sheet.
Thus, even with weaker-than-expected free cash flow in 2018, GE doesn't face a cash crunch. It could maintain its dividend and still pay down debt using the proceeds of its asset-sale activity.
No need for panic
Some analysts think that General Electric could move quickly under new chairman and CEO Larry Culp to bolster its balance sheet through a dividend cut and an accelerated sale of its 62.5% stake in Baker Hughes. (At recent market prices, the Baker Hughes stake is worth about $22 billion.)
Aggressive moves of this sort could potentially help calm investors' nerves. But they aren't necessary, and they may not be in investors' long-term interest. In particular, a hasty sale of GE's Baker Hughes holdings could lead to a lower sale price for that important asset, and might not be a tax-efficient move.
Assuming that General Electric sticks with its plan to spin off its valuable healthcare business next year, it will be able to move a substantial amount of debt and pension liabilities to that new company. As of late June, GE expected the healthcare business to take $18 billion of liabilities with it in the spinoff.
The plan presented back in June also called for GE to monetize 20% of the healthcare unit in conjunction with spinning off the rest to shareholders. Between this action and the other asset sales that are already under contract, GE has the means to quickly pay down half of the net debt in its industrial operations -- even if it distributes all of its free cash flow as dividends.
The healthcare segment makes a huge contribution to GE's free cash flow. As a result, a GE dividend cut at the time of the spinoff is inevitable. The company made that clear at the time that it announced the spinoff plan. Culp and the rest of the board would do well to maintain the current dividend for now and wait until next year's healthcare spinoff to determine the best dividend policy for GE going forward.
